UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______________________ to ______________________
Commission file number 000-19392
DIANON Systems, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 06-1128081
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
200 Watson Boulevard, Stratford, 06615
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Connecticut
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (203) 381-4000
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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None None
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Securities registered pursuant to section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
As of March 4, 1999, the aggregate market value of the voting Common Stock held
by non-affiliates of the registrant was $50,901,341.
Number of shares of Common Stock outstanding as of March 4, 1999: 6,567,915
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement dated October 29, 1998
PART I
ITEM 1. BUSINESS
DIANON Systems, Inc. ("DIANON" or the "Company"), incorporated in 1984,
provides a full line of anatomic pathology testing services and a number of
genetic and clinical chemistry testing services to patients, physicians, and
managed care organizations throughout the United States.
The Company has traditionally been a specialized laboratory with a limited
line of clinical chemistry and anatomic pathology testing services based
principally on new technology purchased or licensed from test developers. This
technology has been marketed directly to medical oncologists and urologists as
testing and information services rather than as products or test kits.
As a result of the Company's success in providing pathology services, the
mission of the Company has been expanded to include a full line of anatomic
pathology services and related information products to physicians, patients and
managed care organizations throughout the United States. The Company's principal
physician audience for these services includes approximately 50,000 clinicians
engaged in the fields of medical oncology, urology, dermatology, gynecology and
gastroenterology. The Company believes it can become one of the leading
specialized providers of anatomic pathology testing services in the United
States.
While the Company continues in its traditional role of assisting
developers of new technology and physicians evaluating such technology, it is
expected that this activity and the Company's clinical chemistry business will
represent a decreasing proportion of total revenue in future years as anatomic
pathology revenues grow.
The business of the Company is subject to a number of risks and
uncertainties that could adversely affect the Company's ability to achieve its
objectives. See "Management's Discussion and Analysis of Results of Operations
and Financial Condition - Risk Factors: Forward Looking Statements" for a
description of various factors that could have an adverse effect on the
performance of the Company.
MEDICAL TESTING MARKETS
The Company operates in one reportable segment, the medical laboratory
industry. Medical laboratories offer a broad range of testing services to the
medical profession. Its testing services are separated based upon the nature of
the test: Anatomic Pathology testing and Clinical Chemistry testing. These
testing services are used by physicians in the diagnosis, prognosis, monitoring
and general management of diseases and other clinical conditions. The tests they
use generally detect medically-significant abnormalities and visual patterns in
blood, tissue samples and other specimens.
Below are some of the major differences between the two testing services:
Anatomic Pathology Testing Clinical Chemistry Testing
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Type of Specimen Tissue or cells - usually obtained Blood or urine usually collected by a nurse
by a physician from a biopsy, Pap (blood) or by the patient (urine)
smear, urine specimen or surgery
Technology Employed Physician interpretation of tissue slides Highly automated blood chemistries and
supplemented by special antibody stains, immunoassays
DNA probes, genetic tests
1991 DIANON Net Revenues $ 9 million $18 million
1998 DIANON Net Revenues $48 million $14 million
The Company offers a complete line of anatomic pathology testing services
as well as selected clinical chemistry tests for cancer and gynecological
conditions. The Company performs all testing at either its main facility in
Stratford, Connecticut or a second laboratory in Tampa, Florida (the latter
acquired in February 1998). It provides most test results to physicians within
forty-eight hours. In 1996, the Company opened a specimen processing facility at
the hub of its airfreight provider in Ohio in order to prepare certain specimens
for more rapid processing when they arrive in Stratford and to improve overall
turnaround time to the physicians. In January 1999, the Company signed a letter
of intent to acquire substantially all the assets of Kyto-Meridien Diagnostics,
LLC, an outpatient OB/Gyn laboratory with locations in Woodbury and New City,
New York. The Company is in the process of conducting due diligence and, subject
to the result of this process, expects to close the acquisition in the second
quarter of 1999.
INFORMATION SERVICES
The Company's information services are used principally to assist the
physician in the analysis of test results and to help managed care organizations
better manage patient treatment. These services complement the Company's current
service offerings and are not a separate product category. Patient specific
reports aid the physician in analyzing multiple prognostic tests and/or
correlative trends in a patient's test results, treatment, and clinical
condition. Summary reports on all patients in a physician's practice allow the
physician to compare test results on patients with similar conditions, review
multiple patient histories, and compare his or her experience with that of
physicians across the country. Similar reports help managed care organizations
capture and compare utilization and diagnostic trends within their own
organization, with other managed care organizations and with the Company's
national database. The Company's current information services are an important
part of the Company's marketing program, and they provide important value-added
services which help the Company differentiate itself from competitors.
QUALITY ASSURANCE
The Company utilizes a unique quality control program for anatomic
pathology which provides a reduced number of equivocal results reported to
clinicians. This program is applied to all anatomic pathology specimens. By
diminishing the number of indeterminate diagnoses and providing the unequivocal
diagnosis as soon as possible, the Company enables clinicians to treat patients
sooner and more effectively while reducing overall health care costs.
The Company's quality assurance program includes adherence by employees to
the Standard Operating Procedures, continuing education and technical training
of technologists, statistical quality control of all analytical processes,
instrument maintenance, and regular inspection by governmental agencies and the
College of American Pathologists.
EUROPEAN OPERATIONS
During 1998 the Company completed the liquidation of its European
operations, which operations were discontinued in 1995.
REIMBURSEMENT
In 1998, 1997 and 1996, respectively, approximately 33%, 37%, and 40% of
the Company's net revenues were derived from testing performed for beneficiaries
under the Medicare and Medicaid programs. At least 90% of this total was derived
from the Medicare program. Revenues from testing performed for other patients
are derived principally from other third-party payors, including commercial
insurers, Blue Cross Blue Shield plans, health maintenance and preferred
provider organizations, patients, physicians, hospitals, and other laboratories
(who in turn usually bill non-governmental third-party payors or patients). For
many of the tests performed for Medicare or Medicaid beneficiaries (except
clinical diagnostic laboratory tests for those beneficiaries being treated by a
hospital or, in some instances, by a skilled nursing facility ("SNF")),
laboratories are required to bill Medicare or Medicaid directly for covered
services and to accept Medicare or Medicaid reimbursement as payment in full for
such services. Management has elected, to date, to accept reimbursement rates
set by other third-party payors as payment in full as well (apart from any
co-payment which the payor has established).
Reimbursement rates for some services of the type or similar to the type
performed by the Company have been established by Medicare, Medicaid and other
third-party payors, but have not been established for all services or by all
carriers with respect to any particular service. While most carriers, including
Medicare, do not cover services they determine to be investigational, or
otherwise not reasonable and necessary for diagnosis or treatment, a formal
coverage determination is made with respect to relatively few new procedures.
When such determinations do occur for Medicare purposes, they most commonly are
made by the local Medicare carrier which processes claims for reimbursement
within the carrier's geographic jurisdiction. The Company receives Medicare
reimbursement primarily through a single Medicare carrier. A positive coverage
determination, or reimbursement without such determination, by one or more
third-party payors, or clearance for market by the Food and Drug Administration
("FDA"), does not assure reimbursement by other third-party payors. A few
third-party payors have denied payment for services for which the Company
receives reimbursement from other payors. On occasion, Medicare or other
third-payors have decided to cease payment for one or more of the Company's
services that historically have been reimbursed by them because such services
are performed using test kits or other products which have not received FDA
pre-market clearance or because such services may otherwise be deemed
investigational or for other reasons. Furthermore, Medicare and other
third-party payors have, on occasion, ceased reimbursement when certain tests
are ordered for patients with certain diagnoses while maintaining reimbursement
when tests are ordered for other diagnoses deemed appropriate by the carrier.
This practice recently has become more prevalent with respect to Medicare.
The Balanced Budget Act of 1997 ("BBA") required the Secretary of the
Department of Health and Human Services ("the Secretary") to divide the country
into no more than five regions and designate a single Medicare carrier for each
region to process laboratory claims (except those performed by independent
physicians' offices) no later than January 1, 1999, and to adopt uniform
coverage, administration, and payment policies for lab tests using a negotiated
rulemaking process by July 1, 1998. The Health Care Financing Administration
("HCFA") has not yet redesignated Medicare carrier regions for lab claims, and
the clinical lab negotiated rulemaking process still is ongoing. Depending on
the details of how these requirements are implemented, they could have an impact
on the Company's future revenues. In general, reimbursement disapprovals by the
various carriers, reductions or delays in the establishment of reimbursement
rates, and carrier limitations on the insurance coverage of the Company's
services or the use of the Company as a service provider could have a material
adverse effect on the Company's future revenues.
Medicare Fee Schedule Payment for Clinical Chemistry Laboratory Services.
Medicare reimbursement for clinical chemistry laboratory services constituted
approximately 23%, 25% and 27% of the Company's clinical chemistry revenues in
1998, 1997 and 1996, respectively. In 1984, Congress adopted legislation
establishing a locality-specific fee schedule reimbursement methodology with
Consumer Price Index ("CPI")-related updates for clinical diagnostic laboratory
testing for non-hospital patients and hospital outpatients under Medicare.
(Payment for clinical chemistry laboratory services performed for Medicare
hospital and SNF inpatients is included within the prospectively determined
Diagnosis Related Group rate paid to the hospital and Resource Utilization Group
rate paid to the SNF.) In addition, state Medicaid programs are prohibited from
paying more than the Medicare fee schedule amount. Beginning with the
Consolidated Omnibus Budget Reconciliation Act of 1985 ("OBRA `85"), Congress
instituted a national cap on Medicare clinical chemistry laboratory fee
schedules. This national cap has been lowered each year and now is 74% of the
national median. The President's fiscal year 2000 budget proposes to reduce this
national cap to 72% of the national median. Moreover, the Omnibus Budget
Reconciliation Act of 1987 ("OBRA '87") eliminated the CPI update for 1988 and,
in succeeding years, Congress has often either limited or eliminated annual
updates of Medicare clinical chemistry laboratory fee schedules. After updates
of 3.2% in 1996 and approximately 2.7% in 1997, the BBA freezes fee schedule
payments for the 1998-2002 period. The update limitations and changes in the
national cap made to date have not had, and are not expected by the Company to
have, a material adverse effect on the Company's results of operations. Any
further significant decrease in such fee schedules, however, could have a
material adverse effect on the Company's future revenues.
The BBA added coverage for a yearly screening pap smear for Medicare
beneficiaries at high risk of developing cervical or vaginal cancer and for
beneficiaries of childbearing age who had not had a negative test in each of the
preceding three years, effective January 1, 1998, as well as coverage for annual
prostate cancer screening, including a prostate-specific antigen blood test, for
beneficiaries over age 50, effective January 1, 2000. Effective January 1, 1999,
Medicare also will make a separate payment for physician interpretation of an
abnormal pap smear in any setting. Prior to 1999, Medicare only covered these
services in an inpatient setting. In addition, it has been reported that HCFA
has been exploring ways to increase reimbursement for thin-layer preparation and
computer assisted pap smears, technologies which the Company uses. Although most
women of childbearing age and men under age 65 are not Medicare beneficiaries,
the addition of Medicare coverage for these tests and higher reimbursement for
certain types of these tests could provide additional revenues for the Company.
Other changes in government and other third-party payor reimbursement
which may result from the enactment of health care reform or of deficit
reduction or balanced budget legislation also likely will continue the downward
pressure on prices and make the market for clinical laboratory services more
competitive. For example, the BBA revised the Medicare program substantially to
permit beneficiaries to choose between traditional fee for-service Medicare and
several non-traditional Medicare options, including managed care plans and
provider-sponsored organization plans. These non-traditional Medicare plans have
considerable discretion in determining whether and how to cover and reimburse
clinical laboratory services and to limit the number of labs with which they
deal.
The BBA also included provisions to implement competitive bidding for
certain Medicare items and services, including laboratory services, on a
three-site demonstration project basis. These changes likely would have an
adverse impact on the Company's revenues if adopted on a widespread basis.
Finally, the BBA contained measures to establish market-oriented purchasing for
Medicare, including prospective payment systems ("PPS") for outpatient hospital
services, home health care, and nursing home care. Of these systems, only the
SNF PPS has been implemented. Since the Company does only minimal clinical
laboratory testing for SNF patients, this change is not expected to materially
affect the Company's business. The BBA directed the Secretary to implement the
PPS for hospital outpatient services by January 1, 1999. Because of Year 2000
computer problems, however, HCFA has asserted that it cannot implement the
outpatient PPS until April 1, 2000, at the earliest. On September 8, 1998, HCFA
published a proposed outpatient PPS rule that would carve out clinical
laboratory services from the outpatient PPS rates, but would include the
technical component of surgical pathology services. The outpatient PPS could
affect the Company's revenues for these surgical pathology services depending on
the precise details of how and when the PPS is implemented.
Because of the uncertainties about how the Medicare changes such as those
described above will be implemented, the Company currently is unable to predict
their ultimate impact on the clinical laboratory industry generally or on the
Company in particular. Even apart from federal legislative action, reforms may
occur at the state level and changes are occurring in the marketplace as a
result of market pressures, including the increasing number of patients covered
by some form of managed care. In general, these changes are likely to put a
downward pressure on price and also may act to limit access by some laboratories
to some managed care patient groups. Because of the uncertainties about the
exact nature, extent, and timing of any such changes, however, the Company
currently is unable to predict their ultimate impact on the clinical industry
generally or on the Company in particular.
Medicare Payment for Anatomic Pathology Services. In addition to
furnishing clinical chemistry laboratory testing services, the Company furnishes
a number of services which are characterized for the purposes of the Medicare
program as anatomic pathology services. Medicare reimbursement for these
services constituted approximately 35%, 40%, and 45% of the Company's net
anatomic pathology revenues in 1998, 1997 and 1996, respectively. As of January
1, 1992, all physician services, including anatomic pathology services, have
been reimbursed by Medicare based on a methodology known as the resource-based
relative value scale ("RBRVS"), which was fully phased in by the end of 1996.
Overall, anatomic pathology reimbursement rates declined during the fee schedule
phase-in period, despite an increase in payment rates for certain pathology
services performed by the Company.
The Medicare RBRVS payment for each service is calculated by multiplying
the total relative value units ("RVUs") established for the service by a
conversion factor that is set by statute. Although originally there were three
conversion factors, the BBA merged them into one effective January 1, 1998. The
1999 conversion factor is $34.7315, a decrease of approximately 5.3% from the
1998 conversion factor. The number of RVUs assigned to each service is in turn
calculated by adding three separate components: physician work, practice
expense, and malpractice expense. In 1997, there was an overall decrease of 5.7%
in payments for pathology services due to a five-year review of the work value
component and a decrease in the 1997 conversion factor applicable to pathology
services, plus an additional decrease in Connecticut, where the Company's
primary operations are located, because of HCFA's reduction of the number of
different payment localities recognized for RBRVS purposes. On November 1, 1998,
HCFA published its final Medicare physician fee schedule regulation that
recalculated the physician practice expense component to reflect resource
consumption rather than historical charge data. The resulting new practice
expense values will be phased in over the period 1999 to 2002. While the actual
impact on the Company's Medicare pathology revenues will depend on the mix of
pathology services furnished, HCFA estimates that the new system will decrease
the Medicare revenue for pathologists 13% once it is fully phased in at the end
of the four-year period. Overall, these fee schedule changes likely will
continue to have a negative effect on the Company's average unit price. The
Company estimates that the adverse impact on revenues in 1999 will not be
material, however.
In the past, the Company has been able to offset a substantial portion of
the impact of the reduced Medicare reimbursement rates for anatomic pathology
services through the achievement of economies of scale and the introduction of
alternative technologies that do not depend on reimbursement through the RBRVS
system. Despite these offsets, the substantial recent modifications to the
physician fee schedule described above, plus the still growing impact of managed
care, likely will continue to have a negative effect on the Company's average
unit price. Other potential legislative and market changes may continue this
trend, including the implementation of an outpatient PPS that bundles the
technical component of surgical pathology services, as described above. However,
the Company is not able to predict the exact nature or effect of any other
potential changes affecting its reimbursement for anatomic pathology services at
this time.
Other Developments Affecting Reimbursement. In 1998, approximately 18% of
the Company's net revenues were in the State of New York. In September 1996, New
York passed the New York Health Care Reform Act of 1996 ("NYHCRA"). The NYHCRA
requires payors to pay an 8.18% surcharge on the services provided by a variety
of providers, including independent laboratories for services rendered to
residents of the State of New York. If the payor neglects to pay the 8.18%
surcharge directly, providers are required to collect the surcharge plus an
additional assessment of 24% of the surcharge for a total surcharge of 32.18%.
Under the NYHCRA, it is possible that independent labs, such as the Company,
will be placed at a competitive disadvantage with physician office labs and
other labs whose services are not subject to the surcharge. In addition,
independent labs probably will be liable for the surcharge even if the payor
fails to pay the laboratory. Moreover, payors may reduce the fees they pay for
laboratory services in order to offset the surcharge. The New York State
Clinical Laboratory Association, which brought suit against the New York State
Department of Health alleging that these provisions of NYHCRA are
unconstitutional under the United States and New York Constitutions and should
not be enforced, is currently appealing an adverse decision on its challenge by
the New York lower court. This association also is working to amend the law.
Nonetheless, the law has been implemented and its impact has been reflected in
the Company's financial statements and could have a negative impact on the
portion of the Company's future net revenues derived from the State of New York.
Following a study of pricing practices in the clinical laboratory
industry, the Office of the Inspector General ("OIG") of HHS conducted a study
of such practices, and in January 1990 issued a final report. This report
addresses how these pricing practices relate to Medicare and Medicaid. The OIG
reviewed the industry's use of one fee schedule for physicians and other
professional accounts and another fee schedule for patients/third-party payors,
including Medicare, in billing for testing services, and focused specifically on
the pricing differential when profiles (or established groups of tests) are
ordered.
Existing federal law authorizes the Secretary of HHS to exclude providers
from participation in the Medicare and Medicaid programs if they charge state
Medicaid programs or Medicare fees "substantially in excess" of their "usual
charges." On September 2, 1998, the OIG issued a final rule in which it
indicated that this provision has limited applicability to services for which
Medicare pays under a PPS or a fee schedule, such as clinical laboratory
services and anatomic pathology services. The Medicaid laws in some states also
have prohibitions related to discriminatory pricing. The Company employs
practices similar to those examined in the 1990 OIG report discussed above in
billing for its services. Depending upon the nature of any regulatory or
enforcement action taken or the content of legislation, if any, which might be
adopted to address this issue, the Company could experience a significant
decrease in revenue which could have a material adverse effect on the Company.
The legislation also provides for civil or criminal penalties or exclusion from
participation in Medicare and Medicaid. The Company is unable to predict at this
time whether any further regulatory, enforcement, or legislative action will be
taken.
In December 1992, an unrelated clinical laboratory, National Health
Laboratories, Inc., ("NHL"), pleaded guilty to submitting false medical
reimbursement claims to the United States government, and entered into a
settlement which provides for payment of over $100 million. The United States
government alleged that NHL, by marketing to physicians diagnostic test panels
which bundled, together with a routine blood chemistry series, two other tests
(ferritin and HDL cholesterol), induced physicians to order these other tests
regardless of medical necessity. While NHL's additional charge to physicians for
these two tests ordered as part of the NHL panel was nominal, NHL billed the
Medicare program for them at full price. Since 1993 and continuing to the
present, other laboratories have reached significant financial settlement with
the government in cases involving similar issues. While it is not possible to
predict how broadly the United States government may seek to expand the theory
of liability it developed in these cases, the Company believes its practices
differ materially from those at issue.
In February 1997, the OIG released a model compliance plan for
laboratories that is based largely on the corporate integrity agreements
negotiated with the laboratories which settled the government's enforcement
actions. The Company has reviewed the model compliance plan and is adopting, or
modifying for adoption, aspects of the model plan that the Company deems
appropriate to the conduct of its business. One key aspect of the corporate
integrity agreements and the model compliance plan is an emphasis on the
responsibilities of laboratories to notify physicians that Medicare covers only
medically necessary services. These requirements, and their likely effect on
physician test ordering habits, focus on chemistry tests, especially routine
tests, rather than on anatomic pathology services or the non-automated tests
which make up the majority of the Company's business measured in terms of net
revenues. Nevertheless, they potentially could affect physicians test ordering
habits more broadly. The Company is unable to predict whether, or to what
extent, these developments may have an impact or the utilization of the
Company's services.
Prior to 1998, the Medical Director of the Connecticut Medicare carrier to
whom the Company submits its Medicare claims orally expressed the view that some
amount of money which the carrier has paid to the Company for certain pathology
services involving DNA measurements in prostate tumor cells (morphometric
analysis of tumor) potentially is recoverable by the carrier. (The company is
not presently submitting claims for this service.) The carrier Medical Director
has never reduced his view to writing or otherwise asserted a claim.
Accordingly, at this time, the Company cannot evaluate any such possible claim,
or the probability of assertion of any such claim.
During 1997, the Company was made aware that an agent based in the
Hartford Connecticut branch of the U.S. Department of Health and Human Services
Office of the Inspector General ("OIG") was investigating the Company's practice
of supplying pathology specimen collection devices without charge to physician
customers as well as unspecified billing issues that had been raised by the
local Medicare carrier. The company believes that its practices with respect to
specimen collection devices were proper, and a letter describing the Company's
actions and its views regarding applicable regulations was sent by the Company
to the OIG. That letter also requested information about any billing issues of
concern to the OIG so that the Company could address them. As of the date of
this report, the Company had not received a response from or otherwise been
contacted by the OIG regarding these matters, and has not received any formal
notification regarding the matter.
Although the Company seeks to structure its practices to comply with all
applicable laws, and management believes such practices are in compliance,
uncertainty nevertheless exists as to how these matters may develop, and the
Company currently is unable to predict their impact, if any, on the Company.
While management does not believe that this matter will have a material adverse
effect on the Company's financial condition, if the carrier and/or OIG agent
were to pursue and prevail on these matters, any significant recoupment of funds
or civil or criminal penalty potentially resulting from such proceedings could
have a material adverse effect on the Company's business and its results of
operations.
COMPETITION
The Company provides services in a segment of the healthcare industry that
is intensely competitive, both with respect to clinical chemistry as well as
anatomic pathology. The Company estimates that there are over 11,500
laboratories in the United States which might be deemed actual or potential
competitors for the testing business of cancer-treating or cancer-diagnosing
physicians.
On the one hand, the anatomic pathology segment is highly fragmented and
has not yet experienced industry consolidation to any significant degree.
Competitors include physician-owned laboratories, specialized commercial
laboratories and hospital laboratories. None of these competitors have a
material share of the anatomic pathology market.
The clinical chemistry segment, on the other hand, has been consolidated
to an extent and the three largest national clinical laboratories in the U.S.:
Quest Diagnostics, SmithKline and Laboratory Corporation of America have a
significant market share in outpatient testing. In February 1999, Quest
Diagnostics announced that it had signed a definitive agreement to acquire the
clinical laboratory operations of SmithKline. Their product offerings are
broader and the three companies have more substantial financial and operational
resources than the Company. Other competitors in this segment include
special-purpose clinical laboratories and manufacturers of test kits and other
diagnostic tools.
In addition to the competition for customers, there is increasing
competition for qualified personnel, particularly in the laboratory. To date,
such competition has not had an adverse impact on the Company's operations.
Significant factors that enhance the Company's ability to compete
effectively include a highly-trained and knowledgeable sales force, high quality
laboratory operations, accurate and consistent test results, quality of service
to physicians, price and speed of turnaround for test results.
PATENTS AND PROPRIETARY TECHNOLOGY
To date, the Company has not relied heavily on patents or licensed
technology in its business. Tests or related diagnostic products purchased by
the Company may or may not be patented. There can be no assurance that such
tests or related products do not infringe patent rights of others. Any such
infringement could give rise to claims against the Company. Typically the
Company is not indemnified against such risks. There can be no assurance that
any issued patent upon which the Company relies directly or indirectly will
afford protection to the Company in the face of challenges to the patent's
validity.
Other private and public entities, including universities, have filed
applications for (or have been issued) patents in the Company's field and may
obtain additional patents and other proprietary rights to technology that may be
the same as or similar to that utilized by the Company. The scope and validity
of such patents, the extent to which the Company may wish or need to acquire
such rights, and the cost or availability of such rights are presently unknown.
There can be no assurance that others may not obtain access to the Company's
technology or independently develop the same or similar technology to that
utilized by the Company.
EMPLOYEES
As of December 31, 1998, the Company had 462 full-time and 40 part-time
employees.
REGULATORY MATTERS
The Company's business is subject to government regulation at the federal,
state and local levels, some of which regulations are described under
"Laboratory," "Food and Drug Administration" and "Other" below.
LABORATORY
The Company's laboratory is certified or licensed under the federal
Medicare program, the Connecticut Medicaid program and the Clinical Laboratories
Improvement Act of 1967, as amended by the Clinical Laboratory Improvement
Amendments of 1988 (collectively, "CLIA `88"). Licensure is maintained under the
clinical laboratory licensure laws of Connecticut, where the Company's clinical
laboratory is located and under the laws of several other jurisdictions. The
Company believes it has obtained all material laboratory licenses required for
its operations. In addition, the laboratory is licensed by the federal Nuclear
Regulatory Commission and is accredited by the College of American Pathology.
The federal and state certification and licensure programs establish
standards for the day-to-day operation of a medical laboratory, including, but
not limited to, personnel and quality control. Compliance with such standards is
verified by periodic inspections by inspectors employed by federal or state
regulatory agencies. In addition, federal regulatory authorities require
participation in a proficiency testing program approved by the HHS for each of
the specialties and subspecialties for which a laboratory seeks approval from
Medicare or Medicaid and licensure under CLIA `88. Proficiency testing programs
involve actual testing of specimens that have been prepared by an entity running
an approved program for testing by the laboratory.
A final rule implementing CLIA `88, published by HHS on February 28, 1992,
became effective September 1, 1992. This rule has been revised on several
occasions and further revision is expected in 1999. The CLIA `88 rule covers all
laboratories in the United States, including the Company's laboratory. The
Company has reviewed its operations as they relate to CLIA, including, among
other things, the CLIA rule's requirements regarding laboratory administration,
participation in proficiency testing, patient test management (including patient
preparation, proper specimen collection, identification, preservation,
transportation, processing and result reporting), quality control, quality
assurance and personnel for the types of testing undertaken by the Company, and
believes it to be in compliance with these requirements. However, no assurances
can be given that the Company's laboratory will pass all future inspections
conducted to ensure compliance with CLIA `88 or with any other applicable
licensure or certification laws.
Existing federal laws governing Medicare and Medicaid, as well as some
state laws, also regulate certain aspects of the relationship between healthcare
providers, including clinical laboratories, and their referral sources,
including physicians, hospitals and other laboratories. One provision of these
laws, known as the "anti-kickback law," contains extremely broad proscriptions,
and relatively little regulatory guidance or judicial precedent exists
concerning its application. Violation of this provision may result in criminal
penalties, exclusion from Medicare and Medicaid and, as of August 5, 1997,
significant civil monetary penalties. Pronouncements from the OIG have indicated
that enforcement resources may be focused on financial arrangements between
laboratories and physicians and other purchasers of laboratory services,
including, for example, arrangements under which laboratories supply physicians'
offices with phlebotomists (blood-drawing technicians) who potentially could
perform additional tasks that normally are the responsibility of the physician
office staff. Under another provision, known as the "Stark" law or
"self-referral prohibition," physicians who have an investment or compensation
relationship with an entity furnishing clinical laboratory services (including
clinical chemistry and anatomic pathology services) may not, subject to certain
exceptions, refer clinical laboratory testing for Medicare patients to that
entity. Similarly, laboratories may not bill Medicare or Medicaid or any other
party for services furnished pursuant to a prohibited referral. Violation of
these provisions may result in disallowance of Medicare and Medicaid claims for
the affected testing services, as well as the imposition of civil monetary
penalties. On August 14, 1995, HHS published a Final Rule implementing this
prohibition on Medicare referrals. On January 9, 1998, in a proposed rule
implementing an extension of the Stark law to other (non-laboratory) services,
HHS proposed some changes in the regulation applicable to laboratories. The
Company does not expect these changes, if they are finalized, to have a major
effect on the Company. The Company seeks to structure its arrangements with
physicians and other customers to be in compliance with the anti-kickback, Stark
and state laws, and to keep up-to-date on developments concerning their
application by various means including consultation with legal counsel. However,
the Company is unable to predict how these laws will be applied in the future,
and no assurances can be given that its arrangement will not become subject to
scrutiny under them. The Company has a compliance committee which meets on a
regular basis to review various operations and relationships as well as adopt
policies.
Any exclusion or suspension from participation in the Medicare and
Medicaid programs, any loss of licensure or accreditation, or any inability to
obtain any required license or permit, whether arising from any action by HHS,
any state, or any other regulatory authority, would have a material adverse
effect on the Company's business. Any significant civil or criminal penalty
resulting from such proceedings could have a material adverse effect on the
Company's business.
FOOD AND DRUG ADMINISTRATION
The FDA does not currently regulate laboratory testing services, which is
the Company's principal business. However, the Company performs some testing
services using test kits purchased from manufacturers for which FDA premarket
clearance or approval for commercial distribution in the United States has not
been obtained by the manufacturers ("investigational test kits"). Under current
FDA regulations and policies, such investigational test kits may be sold by
manufacturers for investigational use only if certain requirements are met to
prevent commercial distribution. The manufacturers of these investigational test
kits are responsible for marketing them under conditions meeting applicable FDA
requirements. In January 1998, the FDA issued a revised draft Compliance Policy
Guide ("CPG") that sets forth FDA's intent to undertake a heightened enforcement
effort with respect to investigational test kits improperly commercialized prior
to receipt of FDA premarket clearance or approval. That draft CPG is not
presently in effect but, if implemented as written, would place greater
restrictions on the distribution of investigational test kits. If the Company
were to be substantially limited in or prevented from purchasing investigational
test kits by reason of the FDA finalizing the new draft CPG, there could be
adverse effects on the Company's ability to access new technology, which could
have a material adverse effect on the Company's business.
The Company also performs some testing services using reagents, known as
analyte specific reagents ("ASRs"), purchased from companies in bulk rather than
as part of a test kit. In November 1997, the FDA issued a new regulation placing
restrictions on the sale, distribution, labeling and use of ASRs, such as those
used by the Company. Most ASRs will be treated by the FDA as low risk devices,
requiring the manufacturing to register with the agency, list its ASRs (and any
other devices), conform to current good manufacturing practices ("CGMPs"), and
comply with medical device reporting of adverse events. A smaller group of ASRs,
primarily those used in blood banking and/or screening for fatal contagious
diseases (e.g., HIV/AIDS), will be treated as higher risk devices requiring
premarket clearance or approval from the FDA before commercial distribution is
permitted. The imposition of this new regulatory framework on ASR sellers may
reduce the availability or raise the price of ASRs purchased by the Company. In
addition, when the Company performs a test developed in-house, using reagents
rather than a test kit cleared or approved by the FDA, it will be required to
disclose those facts in the test report. However, by clearly declining to impose
any requirement for FDA premarket approval or clearance for most ASRs, the new
rule removes one barrier to reimbursement for tests performed using these ASRs.
In light of all the foregoing factors, it is impossible to predict exactly how
the new regulation will affect the Company's business, and thus there can be no
assurance that the new ASR regulation will not have a material adverse effect on
the Company's business.
OTHER
Certain federal and state laws govern the handling and disposal of medical
specimens, infectious and hazardous wastes and radioactive materials. Failure to
comply with such laws could subject an entity covered by these laws to fines,
criminal penalties and/or other enforcement actions.
Pursuant to the Occupational Safety and Health Act, laboratories have a
general duty to provide a work place to their employees that is safe from
hazard. Over the past few years, the Occupational Safety and Health
Administration ("OSHA") has issued rules relevant to certain hazards that are
found in the laboratory. In addition, OSHA recently has promulgated final
regulations containing requirements healthcare providers must follows to protect
workers from bloodborne pathogens. Failure to comply with these regulations,
other applicable OSHA rules or with the general duty to provide a safe work
place could subject an employers, including a laboratory employer, to
substantial fines and penalties.
ITEM 2. PROPERTIES
The Company leases approximately 93,412 square feet of office and
laboratory space in Stratford, Connecticut; Wilmington, Ohio; and Tampa,
Florida. The leases on the Stratford facilities, representing 55,830 square
feet, expires in May 2003, and contain options to renew for up to three years.
The lease for the Wilmington facility, representing 19,200 square feet, expires
March 31, 2001, and contains renewal options for five additional terms of three
years each. The lease on the Tampa office and laboratory facility, representing
18,382 square feet, expires January 31, 2003, with an option to renew for an
additional five-year period. The Company also leases a small office in Stamford,
Connecticut and a record storage facility in Stratford, Connecticut. These
leases expire in November 2000 with an option to renew for up to three years,
and May 2004, respectively.
The Company also leases four regional sales offices located in Florida,
North Carolina, Texas and Ohio, with terms ranging from one to three years, and
four branch offices in Florida with remaining terms of up to two years.
(See Note 5 to the Company's consolidated financial statements included
herewith).
ITEM 3. LEGAL PROCEEDINGS
On November 19, 1997, a suit was filed against the Company in the United
States District Court, District of South Carolina (Frances P. Hadden v. DIANON
Systems, Inc.). The complaint alleged, among other things, medical malpractice
due to an incorrect diagnosis. The claim was settled in 1998 by the Company's
insurance carrier, with the cost to the Company limited to the policy
deductible.
There are no other known material legal proceedings against the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 29, 1998, the Company held its 1998 Annual Meeting of
Shareholders at which the following actions were approved: directors were
elected and the appointment of Arthur Andersen LLP ("Arthur Andersen") as the
Company's independent public accountants for the calendar year ended December
31, 1998 was ratified. The directors elected were Messrs. Kevin C. Johnson,
John P. Davis, E. Timothy Geary, G. S. Beckwith Gilbert, Bruce K. Crowther
and Drs. James B. Amberson and Jeffrey L. Sklar. The table below represents
the votes cast:
Director In Favor Withheld
-------- -------- --------
James B. Amberson, M.D. 6,384,876 53,546
Bruce K. Crowther 6,384,762 53,660
John P. Davis 6,378,598 59,824
E. Timothy Geary 6,384,762 53,660
G. S. Beckwith Gilbert 6,384,053 54,369
Kevin C. Johnson 6,380,444 57,978
Jeffrey L. Sklar, M.D., 6,384,762 53,660
Ph.D.
The other action taken at the Company's 1998 Annual Meeting of
Shareholders, to ratify appointment of Arthur Andersen as the Company's
independent public accountant for the calendar year ending December 31, 1998,
had the following votes cast:
For Withheld Absentions
--- -------- ----------
6,425,068 7,506 5,848
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
DIANON's Common Stock trades on The Nasdaq Stock Market under the symbol
"DIAN." The following table shows the high and low sales prices of the Company's
Common Stock quoted on The Nasdaq Stock Market, for the periods indicated below:
High Low
---- ---
1997:
First Quarter $12-1/2 $8-1/8
Second Quarter 10-1/2 8-3/8
Third Quarter 10-3/8 7-3/4
Fourth Quarter 10 7-1/2
1998:
First Quarter $11-1/4 $8-1/4
Second Quarter 10-7/8 8-1/8
Third Quarter 9-5/8 6
Fourth Quarter 9 5-1/4
As of March 4, 1999, the Company had approximately 2,073 shareholders of
record. No dividends have been paid by DIANON and it is not anticipated that any
will be paid in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
STATEMENT OF OPERATIONS:
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(in thousands, except per share data)
-------------------------------------
Net revenues $62,182 $60,887 $56,000 $45,700 $41,017
Gross profit 26,511 29,766 29,101 25,310 24,300
Expenses:
Selling, general and
administrative
expenses (1) 21,465 22,912 22,443 19,620 17,505
Research and
development 528 1,666 3,157 5,255 4,512
-----------------------------------------------
Income from operations 4,518 5,188 3,500 435 2,283
Net interest income(expense) 682 523 307 181 (90)
Provision for income taxes 2,246 2,413 1,637 509 832
-----------------------------------------------
Net income $2,954 $3,298 $2,170 $ 107 $1,361
===============================================
EPS:
Basic $ .44 $ .51 $ .35 $ .02 $ .26
Diluted $ .43 $ .48 $ .35 $ .02 $ .26
Weighted average shares
outstanding:
Basic 6,678 6,430 6,151 5,542 5,297
Diluted 6,902 6,808 6,287 5,549 5,308
BALANCE SHEET DATA:
Working capital $24,327 $21,387 $18,058 $16,974 $11,931
Total assets 36,703 36,889 34,536 30,455 25,206
Long-term obligations 81 107 272 750 1,674
Stockholders' equity (2) 31,383 29,046 26,549 23,452 18,664
(1) During 1998, 1997, 1996, 1995 and 1994, non-recurring charges relating to
severance costs as a result of streamlining its operations and of the
resignation of certain officers, restructuring, accelerated amortization
and other one-time costs of $212,000, $324,000, $609,000, $2,668,000 and
$692,000, respectively, were incurred. (See Notes 3 and 11 to the Company's
consolidated financial statements included herewith).
(2) No dividends were paid by the Company during the periods presented above.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
The Company's results of operations over the three-year period ended
December 31, 1998 reflect its continued shift toward anatomic pathology testing.
The acquisition of PRL in February 1998 offset the impact of volume mix shifts
during 1998 toward lower margin services, as well as reimbursement decreases
which occurred throughout 1998. The reduced profit impact of these revenue
factors was partially offset through cost savings in selling, general,
administrative and other operating expenses, principally in the early part of
1998.
YEAR 2000 ISSUE
- ---------------
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. As a result, any of
the Company's computer programs that have time-sensitive software may recognize
a date using "00" as their year 1900 rather than the year 2000. This could
result in a system failure or miscalculations causing disruptions of operations,
including among other things, a temporary inability to process transactions,
issue bills, or engage in similar normal business activities.
While the Company believes the remedial measures necessary to address its
internal Year 2000 issues are not material and will require minimal resources to
resolve, it has determined that certain actions are necessary. It has developed
a plan to mitigate its Year 2000 issues, which involves four phases: assessment,
remediation, testing, and implementation. To date, the Company has fully
completed its assessment of all material systems that could be affected by the
Year 2000 issue, and has identified specific systems requiring further action.
Currently, 100% of the Company's software has been remediated, unit tested, and
implemented. Substantial progress has been made with respect to personal
computers, mainframes, servers and laboratory instrumentation. The Company
expects all of its computer hardware to be Year 2000 compliant by the end of the
second half of 1999.
The Company will utilize internal resources to reprogram, or replace,
test, and implement the software for Year 2000 modifications. Management
anticipates that its total Year 2000 project costs will be less than $50,000.
The Company continues to query its important customers, suppliers and
vendors to assess their Year 2000 readiness. As to customers, the most
significant exposure is that associated with the federal government's Medicare
and Medicaid programs and with major insurance companies. These customers in
aggregate represent a material portion of the Company's revenues and
corresponding cash flow. As to suppliers and vendors, the most significant
exposure is that associated with air transportation (substantially all specimens
are flown in overnight and the resulting reports overnighted back to the
customer) and laboratory supplies. To date, the Company is not aware of any
problems that would materially impact results of operations, liquidity, or
capital resources. However, the Company has no means of ensuring that these
customers, suppliers and vendors will be Year 2000 compliant. The inability of
those parties to complete their Year 2000 resolution process could materially
impact the Company. As discussed above, the Company is unaware of any Year 2000
issues related to air transportation. Accordingly, the Company has not developed
a contingency plan in the event its vendors for air transportation are not Year
2000 compliant. The Company will strive to maintain liquidity, through its
credit line and cash position, to mitigate any cash flow risks associated with
the aforementioned Year 2000 exposures.
The Company's plans to complete Year 2000 modification are based on
management's best estimates, which were derived utilizing numerous assumptions
of future events, including the continued availability of certain resources and
other factors. Estimates regarding the status of remediation and the expected
completion dates are based on hours expended to date compared to total expected
hours. However, there can be no guarantee that these estimates will be achieved
and actual results could differ materially from those plans. Specific factors
that might cause such material differences include, but are not limited to, the
availability and cost of personnel training in this area, the ability to locate
and correct all relevant computer codes, and similar uncertainties.
If the Company's modifications and replacements are not made on a complete
or timely basis, the Year 2000 issue could have a material impact on the
operations of the Company.
RESULTS OF OPERATIONS
- ---------------------
o NET REVENUES
Net revenues increased to $62.2 million in 1998 from $60.9 million in 1997
and $56.0 million in 1996, representing annual increases of 2.1% and 8.7%,
respectively.
Anatomic pathology net revenues increased to $48.2 million in 1998 from
$43.9 million in 1997 and $37.0 million in 1996, increases of 9.6% and 18.8%,
respectively. The revenue growth reflects increased penetration in the anatomic
pathology area, including the impact of the PRL acquisition in February 1998,
offset by pricing reductions.
Clinical chemistry net revenues decreased over the three-year period, from
$19.0 million in 1996 to $17.0 million in 1997 and $14.0 million in 1998,
decreases of 10.9% and 17.3%, respectively. These decreases reflect the
Company's shifting emphasis toward anatomic pathology, and are the result of
both volume and pricing reductions, the latter reflecting Medicare reimbursement
pressures.
o COST OF SALES
Cost of sales, which consists primarily of laboratory payroll and
supplies, logistics and facility costs, increased to $35.7 million in 1998 from
$31.1 million in 1997 and $26.9 million in 1996. As a percentage of sales, cost
of sales totaled 57.4%, 51.1% and 48.0% in 1998, 1997 and 1996, respectively.
The increased percentages of revenue represented by cost of sales largely
reflects the impact of a mix shift toward certain lower margin services, the
aforementioned price decreases, and the integration of PRL.
o GROSS PROFIT
Gross profit totaled $26.5 million in 1998 versus $29.8 million in 1997
and $29.1 million in 1996, while gross profit margins were 42.6%, 48.9% and
52.0%, respectively. The decreases in gross profit and margins reflect the
factors discussed above under cost of sales. Also, the increase in anatomic
pathology sales as a percentage of total sales results in higher average unit
pricing with lower gross margin percentages, due to the higher costs associated
with providing these services.
The clinical laboratory industry, which includes both clinical chemistry
and anatomic pathology, has seen steady and continuing downward pressure on
prices exerted by both government and private third party payers. Payment for
services such as those provided by the Company is and will likely continue to be
affected by periodic reevaluations made by payers concerning which services to
reimburse or cease reimbursing, and over time Congress has reduced the national
cap on Medicare laboratory fee schedules (under which the Company's clinical
chemistry services are reimbursed) to 74% of the national median. The
President's fiscal year 2000 budget proposes to reduce this cap even further to
72% of the national median. In addition, legislation freezes fee schedule
payments for the 1998-2002 period.
With respect to the Company's anatomic pathology services, which are not
reimbursed under the Medicare laboratory fee schedules, the Medicare fees also
generally declined with the implementation of the resource-based relative value
scale ("RBRVS") system which went into effect in 1992 and was fully phased in by
the end of 1996. In 1997, there was an overall decrease of 5.7% in payments for
pathology services due to a five-year review of the work value component and a
decrease in the 1997 conversion factor applicable to pathology services, plus an
additional decrease in Connecticut, where the Company's primary operations are
located, because of the Health Care Financing Administration's ("HCFA")
reduction in the number of different payment localities recognized for RBRVS
purposes.
On November 1, 1998, HCFA published its final Medicare physician fee
schedule regulation, which became effective on January 1, 1999. This regulation
decreased the conversion factor by 5.3% in 1999. It also recalculated physician
practice expenses, a key component of the RBRVS, to reflect resource consumption
rather than historical charge data. The resulting new practice expense values
will be phased in over the period 1999 to 2002. While the actual impact on the
Company's Medicare pathology revenues will depend on the mix of pathology
services furnished, HCFA estimates that the new system will decrease the
Medicare revenue for pathologists 13% once it is fully phased in at the end of
the four-year period. Overall, these fee schedule changes likely will continue
to have a negative effect on the Company's average unit price. The Company
estimates that the adverse impact on revenues in 1999 will not be material,
however.
The Balanced Budget Act of 1997 ("BBA") contains measures to establish
market-oriented purchasing for Medicare, including prospective payment systems
("PPS") for outpatient hospital services, home health care, and nursing home
care. Of these systems, only the skilled nursing facility ("SNF") PPS has been
implemented. Since the Company does only minimal clinical laboratory testing for
SNF patients, this change is not expected to materially affect the Company's
business.
The BBA also directs the Secretary of the Department of Health and Human
Services to implement a PPS for hospital outpatient services by January 1, 1999.
Because of Year 2000 computer problems, however, HCFA has asserted that it
cannot implement the outpatient PPS until April 1, 2000, at the earliest. On
September 8, 1998, HCFA published a proposed outpatient PPS rule that would
carve out clinical laboratory services from the outpatient PPS rates, but would
include the technical component of surgical pathology services. The outpatient
PPS could affect the Company's revenues for these surgical pathology services
depending on the precise details of how and when the PPS is implemented.
Other potential changes in government and third-party payer reimbursement,
resulting from federal, state or local legislation, the impact of managed care,
competitive bidding, or other market pressures, are also likely to continue the
downward pressure on prices and make the market for clinical laboratory services
more competitive, which could in turn have a material adverse impact on the
Company's gross profits.
o SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased from $22.9 million
in 1997 to $21.5 million in 1998, after increasing slightly over the $22.4
million incurred in 1996. As a percentage of sales, selling, general and
administrative expenses decreased significantly over the three-year period from
40.0% in 1996 to 34.5% in 1998, reflecting the operating leverage resulting from
the PRL acquisition and general revenue growth, lower marketing expenses in
1998, and lower selling expenses in the early part of 1998 due to changes in the
sales force. These were offset somewhat by increased spending corresponding to
an increase in personnel in the billing department.
o RESEARCH AND DEVELOPMENT
Research and development expenses decreased to $0.5 million in 1998 from
$1.7 million in 1997 and $3.2 million in 1996. The higher expense in 1996
reflects the costs associated with launching the anatomic pathology testing
services, including the cost of building the Company's database. The reduction
in 1997 reflects the completion of this launch, and the further reduction in
1998 partially reflects the evolution of certain developmental test costs from
R&D into cost of sales as those tests have been brought to market and
reimbursement rates are currently being established.
o INCOME FROM OPERATIONS
Income from operations decreased to $4.5 million in 1998, from $5.2
million in 1997 and $3.5 million in 1996, reflecting the factors discussed
above. The relatively modest drop in year-to-date operating income, despite the
larger drop in gross profit, partially reflects cost control initiatives
implemented in anticipation of reimbursement reductions.
o NET INTEREST INCOME
Net interest income grew to $682,000 in 1998 from $522,000 in 1997 and
$307,000 in 1996. This reflects the increased cash and cash equivalent position
of the Company over the period, partially resulting from cash generated by
operations.
o PROVISION FOR INCOME TAXES
The provision for income taxes decreased to $2.2 million in 1998, from
$2.4 million in 1997 and $1.6 million in 1996, while the effective tax rate was
43.2%, 42.2% and 43.0%, respectively.
o NET INCOME
Net income decreased 10.4% to $3.0 million, from $3.3 million in 1997 and
$2.2 million in 1996. Basic earnings per share decreased to $0.44 per share in
1998, from $0.51 per share in 1997 and $0.35 per share in 1996. Diluted earnings
per share decreased to $0.43 per share in 1998, from $0.48 per share in 1997 and
$0.35 per share in 1996.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company had total cash and cash equivalents of
$12.1 million, substantially all of which was invested in a fund holding U.S.
Treasury securities with maturities of less than three months. Working capital
was $24.3 million, $21.4 million and $18.1 million, as of December 31, 1998,
1997 and 1996, respectively and the current ratios were 5.6:1, 3.8:1 and 3.4:1,
respectively.
Accounts receivable (net of allowances) totaled $14.4 million at both
December 31, 1998 and 1997 versus $15.4 as of December 31, 1996, representing
approximately 82 days, 90 days and 79 days of average sales, respectively.
Capital expenditures for 1998, 1997 and 1996 were $2.0 million, $1.9
million, and $3.4 million, respectively. Expenditures in 1998 were primarily
related to information systems enhancements, both medical and billing. In
addition, $360,000 was expended in 1998 toward the acquisition of PRL.
Effective February 17, 1998, the Company entered into a three-year, $15
million line of credit agreement with a bank. The agreement includes various
provisions regarding borrowings under the facility, including those related to
financial covenants. To date, there have been no amounts drawn down under this
line.
As of December 31, 1998, the Company holds 222,019 shares of Common Stock
in treasury at a cost of approximately $1.8 million. In October 1998, the
Company's Board of Directors authorized to repurchase up to an additional 1.5
million shares of the Company's Common Stock, on the open market or in a private
transaction, and that the total expenditures for share repurchases be limited to
an additional $10.0 million, for a total authorization of approximately 1.7
million shares and $12.0 million in total expenditures. The remaining authorized
repurchases as of December 31, 1998 is approximately 1.5 million shares and
$10.2 million in total expenditures.
On January 6, 1999, the Company signed a letter of intent to acquire
substantially all the assets of Kyto-Meridien Diagnostics, LLC, an outpatient
OB/Gyn laboratory with locations in Woodbury and New City, New York. The Company
is in the process of conducting due diligence and, subject to the result of this
process, expects to close the acquisition in the second quarter of 1999. The
Company plans to finance the acquisition through a combination of available cash
and drawdowns of the aforementioned credit line, as well as issuance of Common
Stock, newly issued or treasury shares.
The Company believes that cash flows from operations and available cash
and cash equivalents are adequate to fund the Company's operations for the
foreseeable future.
Risk Factors; Forward Looking Statements
- ----------------------------------------
The Management's Discussion and Analysis and the information provided
elsewhere in this 10K (including, without limitation, in the third and fourth
paragraphs of "Item 1. Business" and under "Gross Profit" and "Liquidity and
Capital Resources" above) contain forward looking statements regarding the
Company's future plans, objectives, and expected performance. These statements
are based on assumptions that the Company believes are reasonable, but are
subject to a wide range of risks and uncertainties, and a number of factors
could cause the Company's actual results to differ materially from those
expressed in the forward-looking statements referred to above. These factors
include, among others, the uncertainties in reimbursement rates and
reimbursement coverage of various tests sold by the Company to beneficiaries of
the Medicare program (see e.g. Item 1 - Business - "Reimbursement"); being
deemed to be not in compliance with Federal or state regulatory requirements
(see e.g. Item 1 - Business - "Regulatory"); the uncertainties relating to the
ability of the Company to convince physicians and/or managed care organizations
to use the Company as a provider of anatomic pathology testing services; the
ability of the Company to maintain superior quality relative to its competitors;
the ability of the Company to maintain its hospital-based business in light of
the competitive pressures and changes occurring in hospital healthcare delivery;
the uncertainties relating to states erecting barriers to the performance of
anatomic pathology testing by out-of-state laboratories; the ability of the
Company to find, attract and retain qualified management and technical
personnel; the uncertainties associated with competitive pressures from the
large national laboratories, small specialized laboratories and well established
local pathologists; and the uncertainties which would arise if integrated
delivery systems closed to outside providers emerged as the dominant form of
health care delivery.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
None
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements and schedule and the
reports of independent public accountants thereon appear beginning on page F-2.
See index to such consolidated financial statements and schedules and reports on
page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following information with respect to the principal occupation or
employment, other affiliations and business experience of each director and
executive officer during the last five years has been furnished to the Company
by such director or executive officer. Except as indicated, each of the
directors and executive officers has had the same principal occupation for the
last five years.
INFORMATION REGARDING DIRECTORS
Set forth below is certain information concerning each director of DIANON
Systems, Inc.
Kevin C. Johnson, age 44, a Director since May 1996, is President and
Chief Executive Officer of the Company. Mr. Johnson joined DIANON as President
in May 1996, and was appointed to the additional position of Chief Executive
Officer in February 1997. Formerly, Mr. Johnson was with Corning Inc., a
manufacturer of specialty materials and a provider of laboratory services, for
eighteen years, serving most recently as Vice President and General Manager of
Corning Clinical Laboratories' Eastern region in Teterboro, New Jersey.
John P. Davis, age 57, a Director since 1984, has served as a consultant
to the Company since October 1, 1998. Mr. Davis was President and Chief
Executive Officer of Infant Advantage, Inc., a child development company from
December 1997 through June 1998. From May 1995 through December 1997, Mr. Davis
was President and Chief Executive Officer of Calypte Biomedical Corp., a
diagnostic products company. From 1984 to January 1995, Mr. Davis was an officer
of the Company. Mr. Davis joined the Company in January 1984 as President and
Chief Operating Officer, and subsequently became co-Chief Executive Officer in
1992 and Chief Executive Officer in 1994. In January 1995, Mr. Davis resigned as
Chief Executive Officer of the Company and became Vice Chairman of the Board. As
of February 1997, Mr. Davis was elected non-executive Chairman of the Board. Mr.
Davis also serves as Chairman of the Board of CytoLogix, Inc.
James B. Amberson, age 47, a Director since January 1995, is Senior Vice
President and Chief Medical Officer of the Company. Dr. Amberson joined DIANON
in 1989 as Director, Cytometry Business Unit, and has served as Vice President
of Pathology Services, Vice President of Medical Affairs and Senior Vice
President and General Manager of the Anatomic Pathology Unit before his present
position. Prior to joining the Company, Dr. Amberson was Assistant Professor of
Pathology, Cornell University Medical College for six years. Dr. Amberson holds
an MD from Johns Hopkins University and an MBA from Columbia University School
of Business.
Bruce K. Crowther, age 47, a Director since December 1997, is President
and Chief Executive Officer of Northwest Community Healthcare, Northwest
Community Hospital, in Arlington Heights, Illinois and certain of its affiliates
since January 1992. Mr. Crowther is a Fellow of the American College of
Healthcare Executives, and immediate past - Chairman of the Board of the
Illinois Hospital and HealthSystems Association and serves on the Board of both
Chicago Hospital Risk Pooling Program and Wintrust Financial Corporation. Mr.
Crowther received an MBA from Virginia Commonwealth University Medical College
in Richmond, VA.
E. Timothy Geary, age 47, a Director since May 1997, had been Chairman,
President and Chief Executive Officer of National Surgery Centers, Inc. of
Chicago, Illinois, the leading independent owner and operator of ambulatory
surgery centers in the country, until its acquisition by HealthSouth Corporation
on July 22, 1998. Prior to founding National Surgery Centers in 1987, Mr. Geary
served as a Vice President with Medical Care International. Mr. Geary is a
member of the Board of Directors of the Federated Ambulatory Surgery
Association. Mr. Geary holds an MBA and BA from the University of Chicago.
G. S. Beckwith Gilbert, age 57, a Director since October 1995, is
President, Chief Executive Officer and a Director of Field Point Capital
Management Company in Greenwich, Connecticut, a merchant banking firm. Mr.
Gilbert is also a partner of Wolsey & Co., a merchant banking firm. In addition,
Mr. Gilbert is Chairman, President and Chief Executive Officer of Megadata
Corporation. He is a Director of Davidson Hubeny Brands, Inc. and Kionix, Inc.
Mr. Gilbert is a graduate of Princeton University and holds an MBA from New York
University. In February 1997, the Board elected Mr. Gilbert Chairman of the
Executive Committee.
Jeffrey L. Sklar, age 51, a Director since 1994, is Professor of
Pathology, Harvard Medical School, and Director, Divisions of Diagnostic
Molecular Biology and of Molecular Oncology, Department of Pathology, Brigham
and Women's Hospital. Dr. Sklar has served on numerous editorial boards and has
consulted widely to the biotechnology industry. In addition, Dr. Sklar serves on
the Scientific Advisory Committee for Clinical Science, The Fred Hutchinson
Cancer Center, Seattle, Washington; the Scientific Advisory Committee, New
England Primate Research Center, Harvard University; the External Review
Committee, Dana-Farber Cancer Institute, Boston, and the Pathology B Study
Section, National Institutes of Health. Dr. Sklar also serves as a Director of
Transgenomic, Inc. and holds an MD and Ph.D. from Yale University and an MA
(honorary) from Harvard University.
COMPENSATION OF DIRECTORS
Directors who are not employees of the Company are paid $1,500 for each
meeting of the Board of Directors attended in person and $500 for each meeting
attended by telephone, and committee members are paid $500 for each committee
meeting attended which does not occur on the same day as a Board meeting.
Directors are also reimbursed for expenses to attend meetings of the Board and
its committees. In addition, the Company has made payments to Brigham & Women's
Hospital, Inc., for which Dr. Sklar is a director, Division of Diagnostic
Molecular Biology, Department of Pathology. See "Compensation Committee
Interlocks and Insider Participation."
Commencing January 1, 1998, Mr. Davis and Mr. Gilbert, in connection with
their capacities as non-Executive Chairman of the Board and Chairman of the
Executive Committee, respectively, also receive $50,000 annually (payable
monthly at $4,166) and an annual grant of 3,000 stock options, at a price equal
to the market value on the date of grant, pursuant to the Company's 1996 Stock
Incentive Plan. They each also received a one-time grant of 13,000 stock options
in December 1997 pursuant to this same plan, in connection with their services
in the aforementioned positions during 1997.
In addition to his aforementioned duties, commencing October 1, 1998 Mr.
Davis began serving as a consultant to the Company, providing approximately two
days per week of consulting services and maintaining an office at the Company.
He works closely with the sales and marketing functions of the Company, and is
involved in the planning and development of sales training programs, recruiting,
compensation planning, market segmentation, pricing, and national and managed
care marketing programs. As compensation for these services, Mr. Davis receives
$50,000 annually (payable monthly at $4,166), in addition to his director
compensation and in addition to the $50,000 he receives in his capacity as
non-Executive Chairman of the Board. In connection with his consulting
arrangement, Mr. Davis was also paid a relocation reimbursement of $123,667 in
February 1999, and will receive in 1999 a payment to reimburse him for the tax
effect of the relocation payment.
Pursuant to the Company's 1996 Stock Incentive Plan, Directors who are not
employees of the Company receive (i) automatic initial and quarterly grants of
stock options with tandem limited stock appreciation rights beginning July 1995,
(ii) automatic quarterly grants of shares of Common Stock beginning January 1997
and (iii) additional stock options or other awards to the extent granted by the
Board of Directors in its discretion.
Each initial and quarterly stock option which is automatically granted
under such plan is exercisable for that number of shares obtained by dividing
$5,000 by the closing price of the Common Stock on the date of grant and is
exercisable at that price. Each such option has a 10-year term and vests with
respect to 10% of the underlying shares on the date which is three months after
the date of grant, and an additional 10% at the end of each three-month period
thereafter. Each such option can be exercised for five years following a
director's termination of service to the extent it had vested prior to
termination. Each automatic quarterly stock grant is for the number of shares
obtained by dividing $2,000 by the closing price of the Common Stock on the date
of grant, and is fully vested at grant.
In November 1996, pursuant to authorization by the Board of Directors, the
Company granted to Dr. Sklar an option to purchase 10,000 shares of Common Stock
at an exercise price of $6.375 to compensate him for his services as a Director.
Such option vests 40% on grant, and an additional 20% on each of August 4, 1997,
August 4, 1998 and August 4, 1999. Such grant is a replacement of an option to
purchase 10,000 shares of Common Stock authorized by the Board in 1994, but not
accepted by Dr. Sklar at that time due to the conditions of his employment by
Brigham & Women's Hospital, Inc. In October 1996, pursuant to authorization by
the Board of Directors, the Company granted an option to purchase 10,000 shares
of Common Stock at an exercise price of $7.125 per share to a director in
replacement of options issued in June 1993 which had the same exercise price,
were due to expire in June 2000 and were 80% vested as of June 4, 1997 with the
remaining 20% vesting on June 4, 1998. These replacement options vested 100% in
October 1996 and expire ten years from the date of grant.
Mr. Johnson and Dr. Amberson, who are employees of the Company, receive
no additional compensation for their services as Directors of the Company.
INFORMATION REGARDING EXECUTIVE OFFICERS
Steven T. Clayton, age 32, has served as Vice President, Information
Services since he joined the Company in December 1996. Prior to joining the
Company, Mr. Clayton was with Corning Clinical Laboratories for nine years
serving most recently as the Midwest Regional Director of Information Systems.
Mr. Clayton holds an ASM from Thomas Edison State College.
Valerie B. Palmieri, age 37, has served as Vice President, Service
Operations since November 1998. Ms. Palmieri joined the Company in December 1987
as a Medical Technologist and subsequently served as Laboratory Supervisor,
Operations Laboratory Manager, Director of Operations, Clinical Pathology, and
Director of Service Operations. Prior to joining the Company, Ms. Palmieri was
with Park City and Bridgeport Hospital as a Medical Technologist. Ms. Palmieri
holds a BS from Western Connecticut State University.
David R. Schreiber, age 39, has served as Senior Vice President, Finance,
Chief Financial Officer and Corporate Secretary since November 1996 when he
joined the Company. Formerly, Mr. Schreiber was with Corning Clinical
Laboratories, a provider of laboratory services, for 10 years, serving most
recently as Vice President and General Manager of the laboratory's Midwest
region. Mr. Schreiber holds an MBA from Northern Illinois University.
Martin J. Stefanelli, age 38, has served as Senior Vice President,
Operations since October 1998. He previously served as Vice President,
Laboratory Operations. Mr. Stefanelli joined the Company in January 1990 as a
Sales Representative and subsequently served as Logistics Manager, Marketing
Manager and Director of Operations, Anatomic Pathology. Before joining the
Company, Mr. Stefanelli was a captain in the U.S. Army. Mr. Stefanelli holds a
BS from the United States Military Academy.
For information with respect to Mr. Johnson and Dr. Amberson, who are also
directors, see ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT -
Information Regarding Directors.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's directors and executive officers, and persons who own more than ten
percent of a registered class of the Company's equity securities, to file with
the Securities and Exchange Commission initial reports of ownership and reports
of changes in ownership of Common Stock and other equity securities of the
Company. Officers, directors and greater than ten percent shareholders are
required to furnish the Company with copies of all Section 16(a) forms they
file.
To the Company's knowledge, based solely on review of the copies of such
reports furnished to the Company and representations that no other reports were
required during the fiscal year ended December 31, 1998, all Section 16(a)
reporting requirements applicable to its officers, directors and greater than
ten percent beneficial shareholders were complied with except for the following:
Dr. Amberson, Mr. Clayton, Mr. Fanuko, Mr. Johnson, Ms. Palmieri, Mr. Schreiber
and Mr. Stefanelli each who was late in filing one grant issued on October 28,
1998 and Mr. Barry (formerly Vice President of Marketing and Technology) filed
one late report with respect to one transaction.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information with respect to the following
named executive officers: (i) the person who served as Chief Executive Officer
("CEO") during 1998 and (ii) the four most highly compensated executive officers
other than the CEO serving at December 31, 1998 whose total salary and bonus for
1998 exceeded $100,000.
SUMMARY COMPENSATION TABLE
Long Term
Annual Compensation Compensation
--------------------------- ------------
Other Securities
Name and Annual Underlying All Other
Principal Position Year Salary Bonus Compensation Options Compensation
------------------ ---- ------ ----- ------------ ------- ------------
Kevin C. Johnson 1998 $295,773 $ -- $ -- 40,000 $184,599 (1)
President, Chief 1997 281,939 82,378 -- -- 158,360
Executive Officer and 1996 174,520 94,000 -- 200,000 1,507
Director
James B. Amberson, M.D 1998 239,200 -- -- 12,000 10,568 (2)
Senior Vice President, 1997 238,790 35,451 -- 20,000 2,630
Chief Medical Officer 1996 200,013 47,869 -- 15,000 2,530
and Director
David R. Schreiber 1998 195,582 -- -- 20,000 6,124 (3)
Senior Vice President 1997 191,170 65,702 -- 20,000 149,167
Finance, Chief Financial 1996 29,231 80,000 -- 50,000 1,742
Officer and Corporate
Secretary
Steven T. Clayton 1998 127,211 -- -- 5,000 43,613 (4)
Vice President, 1997 120,000 35,568 -- 15,000 73,073
Information Services 1996 6,923 14,000 -- 15,000 --
John S. Fanuko (5) 1998 120,046 20,000(6) -- 30,000 77 (7)
Vice President, Finance 1997 -- -- -- -- --
and Corporate 1996 -- -- -- -- --
Controller
(1) The $184,599 indicated for Mr. Johnson represents: (i) a stock grant of
15,000 shares of Common Stock on January 2, 1998 at a market value
totaling $146,250; (ii) a loan forgiveness aggregating $30,000 pursuant to
Mr. Johnson's employment agreement; (iii) an auto allowance of $5,214;
(iv) contributions of $1,600 paid by the Company pursuant to the Company's
401(K) Retirement Plan; and (v) term life insurance premiums of $1,535
paid by the Company.
(2) The $10,568 indicated for Dr. Amberson represents an auto allowance of
$8,028, contributions of $1,600 paid by the Company pursuant to the
Company's 401(K) Retirement Plan, and term life insurance premiums of $940
paid by the Company.
(3) The $6,124 indicated for Mr. Schreiber represents an auto allowance of
$4,440, contributions of $1,600 paid by the Company pursuant to the
Company's 401(K) Retirement Plan and term life insurance premiums of $84
paid by the Company.
(4) The $43,613 indicated for Mr. Clayton represents relocation costs of
$12,267, a tax reimbursement of $31,262 related to relocation costs and
term life insurance premiums of $84 paid by the Company.
(5) Mr. Fanuko joined the Company in January 1998 as Vice President-Finance
and Corporate Controller and resigned from the Company in March 1999.
(6) The $20,000 indicated for Mr. Fanuko represents a sign-on bonus.
(7) The $77 indicated for Mr. Fanuko represents term life insurance premiums
paid by the Company.
STOCK OPTIONS
The following table shows, as to the named executive officers of the
Company, information about option grants in the last fiscal year. The Company,
as of December 31, 1998, has not granted any Stock Appreciation Rights to
officers.
INDIVIDUAL GRANTS
- -------------------------------------------------------------------
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF
NUMBER OF % OF TOTAL STOCK PRICE
SECURITIES OPTIONS EXERCISE APPRECIATION FOR
UNDERLYING GRANTED TO OR OPTION TERM
OPTIONS EMPLOYEES BASE PRICE EXPIRATION --------------------
NAME GRANTED(#) IN 1998 ($/SHARE) DATE 5%($) 10%($)
---- ---------- ------- --------- ---- ------- -------
James B. Amberson, M.D. 12,000 (2) 5% $6.875 10/28/2008 $51,884 $131,484
Steven T. Clayton 5,000 (2) 2% 6.875 10/28/2008 21,618 54,785
John S. Fanuko 15,000 (1) 6% 8.750 01/09/2008 82,542 209,179
John S. Fanuko 15,000 (2) 6% 6.875 10/28/2008 64,855 164,355
Kevin C. Johnson 40,000 (2) 16% 6.875 10/28/2008 172,946 438,279
David R. Schreiber 20,000 (2) 8% 6.875 10/28/2008 86,473 219,140
(1) In January 1998, the Company granted Mr. John S. Fanuko options to
purchase 15,000 shares of Common Stock at $8.75 per share when he joined
the Company. These options vest 40% in January 2000 and 20% during each
year thereafter. Upon termination, all unvested options are cancelled and
all vested options expire 90 days after termination of employment.
(2) In October 1998, the Company granted certain employees and officers
options to purchase 217,000 shares of Common Stock at $6.875 per share.
These options vest 40% in October 2000 and 20% during each year
thereafter. Upon termination, all unvested options are cancelled and all
vested options expire 90 days after termination of employment.
The following table shows aggregate option exercises in the last fiscal
year and fiscal year-end option values for the named executive officers. The
Company, as of December 31, 1998, has not granted any Stock Appreciation Rights.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES
Value
Realized
(Market
Price Value of Unexercised
Shares Number of Securities In-the-money Options At Fy-
Exercise Underlying Unexercised End (based on FY-End Price
Acquired Less Options At Fy-end (#) of $9.00/Share) ($) (1)
On Exercise ----------------------------
Name Exercise(#) Price)($) Exercisable Unexercisable Exercisable Unexercisable
---- ----------- --------- ----------- ------------- ----------- -------------
James B. Amberson, M.D. -- $ -- 46,300 57,200 $189,777 $113,708
Steven T. Clayton -- -- 6,000 29,000 6,750 24,500
John S. Fanuko -- -- 0 30,000 0 35,625
Kevin C. Johnson -- -- 80,000 160,000 265,000 482,500
David R. Schreiber -- -- 20,000 70,000 47,500 118,750
(1) Computed based upon difference between aggregate fair market value and
aggregate exercise price.
EMPLOYMENT AND SEVERANCE AGREEMENTS
The Company entered into an employment agreement with Mr. Johnson on May
2, 1996. The agreement provides for Mr. Johnson to serve as President of the
Company at an initial base salary of $275,000 per annum, the grant of options to
purchase 200,000 shares of Common Stock with a 10-year term and an exercise
price of $5.69, stock grants of 15,000 shares of Common Stock on January 2, 1997
and 15,000 additional shares on January 2, 1998, a signing bonus of $50,000 and
a loan of $150,000. The loan carries an interest rate of 5.9%, payable annually,
and is repayable upon termination of Mr. Johnson's employment with the Company.
If Mr. Johnson continues to be employed with the Company, the loan principal
will be forgiven at the rate of $2,500 per completed month of employment from
January 31, 1998 through December 31, 2002. This agreement provides that in the
event of a termination of Mr. Johnson's employment other than for "Cause," as
defined in the agreement, he is entitled to receive one year's salary and other
benefits. Subject to the foregoing, this agreement is subject to termination at
will by either party.
The Company entered into an employment agreement with David R. Schreiber
on September 30, 1996 as the Chief Financial Officer and Senior Vice President,
Finance. The agreement provides for an initial base salary of $190,000 per
annum, the grant of options to purchase 50,000 shares of Common Stock with a
10-year term and an exercise price of $6.625, a signing bonus of $80,000 and a
stock grant of 7,500 shares of Common Stock on April 1, 1997. This agreement
provides that in the event of a termination of Mr. Schreiber's employment other
than for "Cause," as defined in the agreement, he is entitled to receive one
year's salary (and certain other benefits) if such termination occurs within the
first year of employment or six months after the Company is acquired by another
business entity, or six month's salary (and certain other benefits) if such
termination occurs after such period. Subject to the foregoing, this agreement
is subject to termination at will by either party.
The Company entered into an agreement with James B. Amberson, M.D. on
September 1, 1996, which provides that following a "Change in Control" of the
Company, as defined in the agreement, if Dr. Amberson's employment is terminated
other than for "Cause," as defined in the agreement, he is entitled to receive
one year's salary and bonus and all his stock options will vest completely. Dr.
Amberson's agreement expires in September 2001 and is subject to successive
automatic one-year renewals thereafter (unless certain notice is given).
The Company also entered into an employment agreement with James B.
Amberson, M.D. on September 1, 1996. Pursuant to such agreement, Dr. Amberson is
entitled to a salary as determined by the Company and other employee benefits
made available by the Company to its employees. This agreement provides that in
the event of a termination of Dr. Amberson's employment for other than "Stated
Cause" (as defined in the agreement), he is entitled to receive six month's
salary and other benefits. Subject to the foregoing, this agreement is subject
to termination at will by either party.
The Company entered into an employment agreement with Steven T. Clayton
on November 18, 1996 as Vice President, Information Services of the Company. The
agreement provides for an initial base salary of $120,000 per annum, a signing
bonus of $14,000 and the grant of options to purchase 15,000 shares of Common
Stock with a 10-year term and an exercise price of $7.875.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Dr. Sklar served as a member of the Compensation Committee of the
Company's Board of Directors during the last completed fiscal year and is
continuing to serve as such in the 1999 fiscal year. In 1995 the Company entered
into a three-year research and development agreement with Brigham & Women's
Hospital, Inc., for which Dr. Sklar is director, Division of Diagnostic
Molecular Biology, Department of Pathology. The agreement required the Company
to make quarterly payments of $30,000 in exchange for an option to obtain rights
in certain existing inventions as well as inventions developed during the course
of the research in the areas of cancer detection and diagnosis. The research was
to be conducted by Dr. Sklar. The Company paid $8,000, $60,000, $120,000 and
$60,000 under this agreement in 1998, 1997, 1996 and 1995, respectively. The
Company terminated this agreement effective as of June 30, 1997 and has made all
required payments. In addition, the Company made payments to Brigham & Women's
Hospital, Inc. of $30,000 in 1996 for consulting services.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The information required by this item is included in the registrant's
definitive proxy statement for the 1998 Annual Meeting of Shareholders and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
OWNERSHIP OF VOTING STOCK BY CERTAIN BENEFICIAL OWNERS
The following table sets forth information with respect to the only
persons who, to the best knowledge of the Company as derived from Schedules 13F,
13D and 13G filed by such persons, beneficially owned more than five percent of
the Common Stock of the Company as of March 4, 1999. Unless otherwise indicated
below, each person included in the table has sole voting and investment power
with respect to all shares included therein.
Amount and Nature Percent
Name and Address of of Beneficial of
Title of Class Beneficial Owner Ownership Class(1)
- -------------- ---------------- --------- --------
Common Stock G. S. Beckwith Gilbert et al 1,809,452 (2)(3) 27.5% (3)
66 Field Point Road
Greenwich, CT 06830
Common Stock Oracle Management Partners, 688,400 10.5%
Inc. and Affiliates
712 E 5th Avenue - 45th Floor
New York, NY 10019
Common Stock John M. Bryan et al 356,412 5.4%
Bryan and Edwards
600 Montgomery Street -
35th Floor San Francisco, CA 94111
(1) For the purposes of this table, "Percent of Class" held by each person has
been calculated based on a total class equal to the sum of (i) 6,567,915
shares of Common Stock issued and outstanding on March 4, 1999 plus (ii)
for such person the number of shares of Common Stock subject to stock
options or warrants presently exercisable, or exercisable within 60 days
after March 4, 1999, held by that person, and which percent is rounded to
the nearest whole number.
(2) Mr. Gilbert has shared voting and investment power with respect to 121,951
shares included in the table above.
(3) As of March 4, 1999, Mr. Gilbert cannot vote, without restriction, any
Common Stock or other voting securities of the Company beneficially owned
by him representing greater than 20% of the total voting power of the
Company's voting securities outstanding from time to time, or 1,313,583
votes as of March 4, 1999. Excess votes above this amount are required to
be voted in proportion to the votes cast by all other shareholders of the
Company.
OWNERSHIP OF VOTING STOCK BY MANAGEMENT
The following table gives information concerning the beneficial ownership
of the Company's Common Stock as of March 4, 1999 by each director and each of
the executive officers named in the summary compensation table and all current
directors and executive officers (as of March 4, 1999) as a group.
Total Shares
Beneficially Direct Right to Percent of
Beneficial Owners Owned(1)(2) Ownership Acquire(3) Class(4)
- ----------------- ----------- --------- ---------- --------
James B. Amberson, M.D. 95,384 31,402 46,300 1.4%
Steven T. Clayton 6,000 -- 6,000 -- (5)
Bruce K. Crowther 2,339 1,196 1,143 -- (5)
John P. Davis 242,675 118,325 124,350 3.6%
John S. Fanuko -- -- -- -- (5)
E. Timothy Geary 3,595 1,642 1,953 -- (5)
G. S. Beckwith Gilbert 1,809,452 1,802,105 7,347 27.5% (6)
Kevin C. Johnson 168,340 30,658 120,000 2.5%
David R. Schreiber 45,182 7,500 20,000 -- (5)
Jeffrey L. Sklar, M.D., Ph.D. 18,371 2,105 16,266 -- (5)
All current directors and
executive officers as a 2,363,274 1,994,985 350,607 34.2%
group (12 persons)
(1) The information as to beneficial ownership is based on statements furnished
to the Company by its executive officers and directors. Each executive
officer and director has sole voting and sole investment power with respect
to his respective shares listed above, except that the shares reported for
Mr. Gilbert include 121,951 shares which are held by a trust of which Mr.
Gilbert is a trustee, as to which Mr. Gilbert shares voting and investment
powers. Amounts shown for each of Messrs. Johnson and Schreiber and Dr.
Amberson include 17,682 shares held in the Company's 401(K) Retirement
Plan, as to which such officers share voting power as trustees of such plan
and each individual plan participant has investment power, subject to the
terms of such plan, of the shares in his account; such amount includes 658
shares in Mr. Johnson's account.
(2) Includes shares listed under the captions "Direct Ownership" and "Right to
Acquire," as well as shares held in the Company's 401(K) Retirement Plan
which are beneficially owned by the named individuals as trustees of such
plan but as to which such trustees have no economic interest.
(3) Individuals have the right to acquire these shares within 60 days of March
4, 1999 by the exercise of stock options or through purchases under the
Company's Employee Stock Purchase Plan.
(4) For the purposes of this table, "Percent of Class" held by each individual
has been calculated based on a total class equal to the sum of (i)
6,567,915 shares of Common Stock issued and outstanding on March 4, 1999
plus (ii) for such individual the number of shares of Common Stock subject
to stock options presently exercisable, or exercisable within 60 days after
March 4, 1999, held by that individual, and which percent is rounded to the
nearest whole number.
(5) Owns less than 1% of the outstanding Common Stock.
(6) As of March 4, 1999, Mr. Gilbert cannot vote, without restriction, any
Common Stock or other voting securities of the Company beneficially owned
by him representing greater than 20% of the total voting power of the
Company's voting securities outstanding from time to time, or 1,313,583
votes as of March 4, 1999. Excess votes above this amount are required to
be voted in proportion to the votes cast by all other shareholders of the
Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See Item 11 - Executive Compensation - "Compensation Committee Interlocks
and Insider Participation" and Notes 6 and 13 of the Company's consolidated
financial statements included herewith.
Pursuant to his employment agreement, the President of the Company
received a loan in 1996 totaling $150,000 which bears interest at 5.9%, payable
annually, and is repayable upon termination of his employment with the Company.
In addition, the loan principal will be forgiven at a rate of $2,500 per month
over the period January 1998 through December 2002 if the President continues to
be employed by the Company.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements, Financial Statement Schedules Filed.
1) Financial Statements - See accompanying Consolidated Financial
Statements and Schedules, Pages F-1 through F-18.
2) Financial Statement Schedules - See accompanying Consolidated
Financial Statements and Schedules, Pages F-1 through F-18.
3) Exhibits - Refer to 14(c) below.
(b) The Company filed no reports on Form 8-K in the fourth quarter of 1998
with the Securities and Exchange Commission.
(c) Exhibit Index
3.1 Restated Certificate of Incorporation of the Company, as amended through
June 12, 1991 (incorporated by reference to Exhibit 3.1 of the
Registrant's Registration Statement No. 33-41226).
3.2 Restated By-Laws of the Company, as amended through October 24, 1996
(incorporated by reference to Exhibit 4.2 of the Registrant's Registration
Statement No. 333-18817).
3.3 Restated By-Laws of the Company, as amended through February 2, 1997
(incorporated by reference to Exhibit 4.2 of the Registrant's Registration
Statement No. 333-18817).
10.1 Consulting Agreement, dated August 4, 1989, between DIANON Systems, Inc.
and Nonda Katopodis, Ph.D. (incorporated by reference to Exhibit 10.7 of
the Registrant's Registration Statement No. 33-41226).**
10.2 Executive Vesting Agreement, dated as of June 11, 1991, between DIANON
Systems, Inc. and James B. Amberson, M.D. (incorporated by reference to
Exhibit 10.13 of the Registrant's Registration Statement No. 33-41226).**
10.3 1991 Stock Incentive Plan (incorporated by reference to Exhibit 10.17 of
the Registrant's Registration Statement No. 33-41226).**
10.4 Management Incentive Plan (incorporated by reference to Exhibit 10.18 of
the Registrant's Registration Statement No. 33-41226).**
10.5 Stock Option Grant to Walter O. Fredericks, dated April 27, 1990
(incorporated by reference to Exhibit 10.23 of the Registrant's
Registration Statement No. 33-41226).**
10.6 Stock Option Grant to Richard A. Sandberg, dated June 12, 1991
(incorporated by reference to Exhibit 10.24 of the Registrant's
Registration Statement No. 33-41226).**
10.7 Stock Option Grant to Richard A. Sandberg, dated June 12, 1991
(incorporated by reference to Exhibit 10.25 of the Registrant's
Registration Statement No. 33-41226).**
10.8 Lease Agreement, made as of February 14, 1989, between Watson Boulevard
Development Limited Partnership, as lessor, and DIANON Systems, Inc., as
lessee, for premises located at 200 Watson Boulevard (incorporated by
reference to Exhibit 10.29 of the Registrant's Registration Statement No.
33-41226).
10.9 License Agreement, dated June 9, 1983, between Sloan-Kettering Institute
for Cancer Research and N-K Laboratories Limited Partnership (incorporated
by reference to Exhibit 10.30 of the Registrant's Registration Statement
No. 33-41226).
10.10 License Agreement, dated July 29, 1987, between University of Rochester
and DIANON Systems, Inc. (incorporated by reference to Exhibit 10.32 of
the Registrant's Registration Statement No. 33-41226).
10.11 Development Agreement, effective September 25, 1987, between Connecticut
Product Development Corporation and DIANON Systems, Inc. (incorporated by
reference to Exhibit 10.33 of the Registrant's Registration Statement No.
33-41226).
Exhibit Index (continued)
10.12 Stock Option Grant to James B. Amberson, M.D., dated April 23, 1991
(incorporated by reference to Exhibit 28.1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1991).**
10.13 Stock Option Grant to Richard A. Sandberg, dated June 12, 1991, as amended
(incorporated by reference to Exhibit 10.37 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1991).**
10.14 Asset Purchase Agreement, dated April 30, 1993, by and among the
Registrant and Molecular Oncology, Inc., and Oncologix, Inc. (incorporated
by reference to Exhibit 1.1 to the Registrant's Form 8-K dated April 30,
1993, filed with the Securities and Exchange Commission on May 14, 1993).
10.15 Asset Purchase Agreement, dated June 29, 1993, by and among the Registrant
and Collaborative Research, Inc. (incorporated by reference to Exhibit 1.2
to the Registrant's Form 8-K dated June 29, 1993, filed with the
Securities and Exchange Commission on July 13, 1993).
10.16 Term Loan Agreement, dated July 14, 1993, by and among the Registrant and
the Union Trust Company (incorporated by reference to Exhibit 10.34 to the
Registrant's Annual Report on Form 10-K/A Amendment 1 for the year ended
December 31, 1993, filed with the Securities and Exchange Commission on
April 28, 1994).
10.17 Rights Agreement, dated April 29, 1994, by and among the Registrant and
American Stock and Trust Company, as Rights Agent (incorporated by
reference to Exhibit 1 to the Registrant's Form 8-K dated April 29, 1994,
filed with the Securities and Exchange Commission on May 9, 1994).
10.18 Severance Agreement, dated January 20, 1995, by and among the Registrant
and John P. Davis (incorporated by reference to Exhibit 10.36 to the
Registrant's Annual Report on Form 10-K for the year ended December 31,
1995, filed with the Securities and Exchange Commission on March 29,
1996).**
10.19 Employment Agreement, dated May 3, 1996, by the Registrant and Kevin C.
Johnson (incorporated by reference to Exhibit 10.37 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1996).**
10.20 Executive Employment Agreement, dated September 1, 1996, by the Registrant
and Richard A. Sandberg (incorporated by reference to Exhibit 10.38 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended September
30, 1996).**
10.21 Employment Agreement, dated September 1, 1996, by the Registrant and James
B. Amberson, M.D. (incorporated by reference to Exhibit 10.39 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended September
30, 1996).**
10.22 Executive Employment Agreement, dated September 1, 1996, by the Registrant
and James B. Amberson, M.D. (incorporated by reference to Exhibit 10.40 to
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996).**
10.23 Severance Agreement, dated September 27, 1996, by the Registrant and Carl
R. Iberger (incorporated by reference to Exhibit 10.41 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1996).**
10.24 Employment Agreement, dated September 30,1996, by the Registrant and David
R. Schreiber (incorporated by reference to Exhibit 10.42 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended September
30, 1996).**
10.25 Employment Agreement, dated November 18, 1996, by the registrant and
Steven T. Clayton.**
10.26 Severance Agreement dated November 18, 1996, by the registrant and Daniel
J. Cronin, III.**
10.27 Amendment dated as of October 4, 1995 to Rights Agreement dated as of
April 29, 1994 between the Registrant and American Stock Transfer and
Trust Company, as Rights Agent (incorporated by reference to Exhibit No. 1
to the Registrant's Form 8-K dated October 30, 1996 filed with the
Securities and Exchange Commission on November 8, 1995).
10.28 1996 Stock Incentive Plan (incorporated by reference to Appendix A to the
Registrant's Statement on Schedule 14A filed with the Securities and
Exchange Commission on September 23, 1996).**
10.29 Stock and Warrant Purchase Agreement, dated as of October 4, 1995, among
the Gilbert Family Trust, the G. S. Beckwith Gilbert I.R.A. Contributory
Account, G. S. Beckwith Gilbert and the Registrant.
10.30 Registration Rights Agreement, dated as of October 4, 1995, among the
Gilbert Family Trust, the G. S. Beckwith Gilbert I.R.A. Contributory
Account, G. S. Beckwith Gilbert and the Registrant.
10.31 Warrant No. 1, dated as of October 4, 1995, by the Registrant in favor of
G. S. Beckwith.
10.32 Promissory Note, dated October 4, 1995, by G. S. Beckwith Gilbert in favor
of the Registrant.
10.33 Stock Option Grant dated October 24, 1996 by the Registrant to Andre de
Bruin.**
Exhibit Index (continued)
10.34 Stock Option Grant dated November 4, 1996 by the Registrant to Jeffrey M.
Sklar, M.D., Ph.D.**
10.35 Loan Agreement dated December 3, 1996 by the Registrant to Kevin C.
Johnson).**
10.36 Form of standard Stock Option Grant for outside directors.**
10.37 Amendment to Warrant Certificate No. W-1 dated as of October 2, 1996
between the Registrant and G. S. Beckwith Gilbert.
10.38 Severance Agreement dated February 27, 1997 by the Registrant and Richard
A. Sandberg.**
10.39 Amendment dated April 30, 1997 by the Registrant and Richard A.
Sandberg.**
10.40 Security Agreement dated April 30, 1997 by the Registrant and Richard A.
Sandberg.**
10.41 Secured Promissory Note dated April 30, 1997 by the Registrant and Richard
A. Sandberg.**
10.42 Non-Compete Agreement dated September 3, 1997 by the Registrant and Vernon
L. Wells.**
10.43 Severance Agreement dated September 15, 1997 by the Registrant and Robert
C. Verfurth.**
10.44 Consulting and Proprietary Information and Inventions Agreement dated
October 1, 1997 by the Registrant and Jeffrey L. Sklar, M.D., Ph.D.
10.45 Severance Agreement dated January 27, 1998 by the Registrant and Vernon L.
Wells.**
11.1 Statement re: computation of per share earnings. *
22.1 List of Subsidiaries of the Company (incorporated by reference to Exhibit
22.1 of the Registrant's Registration Statement No. 33-41226).
23.1 Consent of Arthur Andersen LLP (filed herewith).
27.1 Financial Data Schedule.
- --------------
* Not applicable or contained elsewhere herein.
** A management contract or compensatory plan or arrangement required
to be filed as an exhibit to this form pursuant to Item 14(c) of
this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DATED: March 19, 1999
DIANON SYSTEMS, INC.
By: /s/ KEVIN C. JOHNSON
----------------------------------
Kevin C. Johnson,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ KEVIN C. JOHNSON President and March 19, 1999
--------------------------------- Chief Executive Officer
Kevin C. Johnson and a Director
(Principal Executive
Office)
/s/ DAVID R. SCHREIBER Senior Vice President, March 19, 1999
--------------------------------- Finance and Chief
David R. Schreiber Financial Officer
(Principal Financial
and Accounting Officer)
/s/ JOHN P. DAVIS Chairman of the Board March 19, 1999
---------------------------------
John P. Davis
/s/ G. S. BECKWITH GILBERT Director and Chairman March 19, 1999
--------------------------------- of the Executive
G. S. Beckwith Gilbert Committee
/s/ JAMES B. AMBERSON, M.D. Director, Chief Medical March 19, 1999
--------------------------------- Officer and Senior Vice
James B. Amberson, M.D. President
/s/ BRUCE K. CROWTHER Director March 19, 1999
---------------------------------
Bruce K. Crowther
/s/ E. TIMOTHY GEARY Director March 19, 1999
---------------------------------
E. Timothy Geary
/s/ JEFFREY L. SKLAR, M.D., Ph.D. Director March 19, 1999
---------------------------------
Jeffrey L. Sklar, M.D., Ph.D.
DIANON SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Page
----
Report of Independent Public Accountants F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997 F-3 & F-4
Consolidated Statements of Operations for the Years Ended
December 31, 1998, 1997 and 1996 F-5
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1998, 1997 and 1996 F-6
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 F-7 & F-8
Notes to Consolidated Financial Statements F-9 to F-18
Schedules:
Report of Independent Public Accountants F-19
Schedule II - Valuation and Qualifying Accounts F-20
All other schedules required by Regulation S-X have been omitted because
they are not applicable or because the required information is included in the
consolidated financial statements or notes thereto.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To DIANON Systems, Inc.:
We have audited the accompanying consolidated balance sheets of DIANON
Systems, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1998
and 1997, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of DIANON Systems, Inc. and
subsidiaries as of December 31, 1998 and 1997 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
As explained in Note 3 to the financial statements, effective January 1,
1998, the Company changed its method of accounting for internally developed
software costs to conform with Statement of Position 98-1 "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use."
ARTHUR ANDERSEN LLP
Stamford, Connecticut,
February 23, 1999
DIANON SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS AS OF
DECEMBER 31, 1998 AND 1997
1998 1997
-------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $12,126,076 $12,401,062
Accounts receivable, net of allowances of
$1,033,059 and $1,292,095, at December 31,
1998 and 1997, respectively 14,403,878 14,444,767
Prepaid expenses and employee advances 1,007,577 529,887
Inventory 981,647 729,658
Deferred income taxes 1,047,118 1,016,797
--------------------------
Total current assets 29,566,296 29,122,171
--------------------------
PROPERTY AND EQUIPMENT, at cost
Laboratory and office equipment 10,367,848 8,489,323
Leasehold improvements 3,786,759 3,676,200
Less - accumulated depreciation and
amortization (8,620,122) (6,057,511)
--------------------------
5,534,485 6,108,012
--------------------------
INTANGIBLE ASSETS, net of accumulated amortization
of $3,181,779 and $3,207,570, at December 31,
1998 and 1997, respectively 377,751 388,030
DEFERRED INCOME TAXES 1,005,869 670,191
OTHER ASSETS 218,714 600,657
==========================
TOTAL ASSETS $36,703,115 $36,889,061
==========================
DIANON SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS AS OF
DECEMBER 31, 1998 AND 1997 (CONTINUED)
1998 1997
--------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $1,260,620 $1,540,922
Accrued employee compensation 576,335 1,631,180
Accrued employee stock purchase plan 31,996 549,619
Accrued income taxes payable 309,623 747,564
Current portion of capitalized lease obligations 42,334 41,470
Other accrued expenses 3,018,468 3,224,613
--------------------------
Total current liabilities 5,239,376 7,735,368
--------------------------
LONG-TERM PORTION OF CAPITALIZED LEASE OBLIGATIONS 80,675 107,449
--------------------------
Total liabilities 5,320,051 7,842,817
--------------------------
STOCKHOLDERS' EQUITY:
Common stock, par value $.01 per share,
20,000,000 shares authorized, 6,808,729
and 6,791,320 shares issued and outstanding
at December 31, 1998 and 1997,respectively 68,088 67,914
Additional paid-in capital 27,398,120 27,880,223
Retained earnings 5,697,710 2,743,380
Common stock held in treasury, at cost -
222,019 and 197,617 shares at December 31,
1998 and 1997, respectively (1,780,854) (1,645,273)
--------------------------
Total stockholders' equity 31,383,064 29,046,244
--------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $36,703,115 $36,889,061
==========================
The accompanying notes to consolidated financial statements are
an integral part of these balance sheets.
DIANON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
-------------------------------------
NET REVENUES $62,181,503 $60,887,193 $55,998,995
COST OF SALES 35,670,153 31,121,507 26,897,576
-------------------------------------
GROSS PROFIT 26,511,350 29,765,686 29,101,419
SELLING, GENERAL, AND ADMINISTRATIVE
EXPENSES 21,464,737 22,912,147 22,443,192
RESEARCH AND DEVELOPMENT EXPENSES 528,478 1,665,735 3,157,846
-------------------------------------
INCOME FROM OPERATIONS 4,518,135 5,187,804 3,500,381
INTEREST INCOME, NET 682,138 522,427 306,840
-------------------------------------
INCOME BEFORE PROVISION FOR INCOME
TAXES 5,200,273 5,710,231 3,807,221
PROVISION FOR INCOME TAXES 2,245,943 2,412,534 1,637,105
-------------------------------------
NET INCOME $2,954,330 $3,297,697 $2,170,116
=====================================
EARNINGS PER SHARE:
BASIC $ .44 $ .51 $ .35
DILUTED $ .43 $ .48 $ .35
WEIGHTED AVERAGE SHARES OUTSTANDING:
BASIC 6,677,524 6,430,060 6,151,061
DILUTED 6,902,080 6,808,250 6,287,159
The accompanying notes to consolidated financial statements
are an integral part of these statements.
DIANON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
Additional Retained Common Stock Shareholder
Common Stock Paid-In Earnings Acquired for Treasury Note
Shares Amount Capital (Deficit) Shares Amount Receivable Total
-----------------------------------------------------------------------------------------------
BALANCE, December 31, 1995 6,311,451 $63,115 $26,609,627 ($2,724,43) (50,000) ($200,000) ($296,000) $23,452,339
Stock options exercised 23,621 236 107,476 -- -- -- -- 107,712
Exercise of warrants, net
of exercise costs 377,702 3,777 1,536,540 -- 422,298 2,478,889 -- 4,019,206
Common stock acquired
for treasury -- -- -- -- (489,494 (3,208,332) -- (3,208,332)
Extinguishment of shareholder
note receivable -- -- (296,000) -- -- -- 296,000 --
Stock compensation expense -
stock options -- -- 7,887 -- -- -- -- 7,887
Net income -- -- -- 2,170,116 -- -- -- 2,170,116
-----------------------------------------------------------------------------------------------
BALANCE, December 31, 1996 6,712,774 67,128 27,965,560 (554,317) (117,196) (929,443) -- 26,548,928
Stock options exercised 51,764 518 248,498 -- -- -- -- 249,016
Employee stock purchase plan -- -- (564,822) -- 146,579 1,220,200 -- 655,378
Stock grants 26,782 268 230,987 -- -- -- -- 231,255
Common stock acquired
for treasury -- -- -- -- (227,000) (1,936,030) -- (1,936,030)
Net income -- -- -- 3,297,697 -- -- -- 3,297,697
-----------------------------------------------------------------------------------------------
BALANCE, December 31, 1997 6,791,320 67,914 27,880,223 2,743,380 (197,617) (1,645,273) -- 29,046,244
Stock options exercised 53,584 535 288,012 -- -- -- -- 288,547
Employee stock purchase plan -- -- (499,193) -- 131,498 1,094,800 -- 595,607
Stock grants 19,825 199 186,018 -- -- -- -- 186,217
Common stock acquired
for treasury -- -- -- -- (211,900) (1,687,881) -- (1,687,881)
Retired shares (56,000) (560) (456,940) -- 56,000 457,500 -- --
Net income -- -- -- 2,954,330 -- -- -- 2,954,330
===============================================================================================
BALANCE, December 31, 1998 6,808,729 $68,088 $27,398,120 $5,697,710 (222,019) ($1,780,854) $ -- $31,383,064
===============================================================================================
The accompanying notes to consolidated financial statements
are an integral part of these statements.
DIANON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $2,954,330 $3,297,697 $2,170,116
Adjustments to reconcile net income
to net cash provided by (used in)
operations -
Non-cash charges
Depreciation and amortization 2,786,821 3,109,515 2,463,325
Stock compensation expense 186,217 231,255 7,887
Loss on disposal of fixed assets -- 55,241 27,240
Investment write-down -- -- 61,846
Deferred tax provision (365,999) (753,197) (168,539)
Changes in other current assets
and liabilities
Decrease (increase) in accounts
receivable 337,054 981,454 (5,772,250)
(Increase) decrease in prepaid
expenses and employee advances (183,473) 988,623 (278,127)
Increase in inventory (212,042) (67,091) (108,169)
(Increase) decrease in other assets 256,073 (160,853) (320,176)
(Decrease) increase in accounts
payable and other accrued liabilities (2,979,916) 646,762 1,740,665
------------------------------------
Net cash provided by (used in)
operating activities 2,779,065 8,329,406 (176,182)
------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,864,824) (1,860,646) (3,431,895)
Acquisition of PRL, net of debt assumed (359,590) -- --
Other -- 16,124 81,161
------------------------------------
Net cash (used in) investing
activities (2,224,414) (1,844,522) (3,350,734)
------------------------------------
DIANON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (CONTINUED)
1998 1997 1996
--------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of common stock held in
treasury ($1,687,881) ($1,936,030) ($3,208,332)
Net borrowings (repayments) of
capitalized lease obligations (25,910) 109,378 22,839
Repayments of note payable -- (650,154) (916,150)
Net proceeds from exercise of warrants -- -- 4,019,206
Exercise of stock options 288,547 249,016 107,712
Employee stock purchase plan 595,607 655,378 --
---------------------------------------
Net cash (used in) provided by
financing activities (829,637) (1,572,412) 25,275
---------------------------------------
Net (decrease) increase in cash and
cash equivalents (274,986) 4,912,472 (3,501,641)
CASH AND CASH EQUIVALENTS,
beginning of year 12,401,062 7,488,590 10,990,231
---------------------------------------
CASH AND CASH EQUIVALENTS,
end of year $12,401,062 $12,126,076 $ 7,488,590
=======================================
SUPPLEMENTAL CASH FLOWS DISCLOSURES:
Cash paid during the year:
Interest $ 20,275 $ 27,416 $ 77,782
Income taxes 2,883,890 2,171,422 1,712,200
The accompanying notes to consolidated financial statements
are an integral part of these statements.
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) THE COMPANY
DIANON Systems, Inc. (the "Company") provides a full line of anatomic
pathology testing services, as well as a number of genetic and clinical
chemistry testing services to patients, physicians and managed care
organizations throughout the United States. A significant portion of the
services provided by the Company are paid for by either the patients' Medicare
or private medical insurance carriers. The remaining services are generally paid
for by patients, physicians or hospitals directly.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", requires that the Company disclose selected information about
operating segments in its annual and interim financial statements, commencing
with the fiscal year 1998 financial statements. The Company operates in one
reportable segment, the medical laboratory industry. Its testing services are
separated based upon the nature of the test: anatomic pathology testing and
clinical chemistry testing. Anatomic pathology testing is characterized by
tissue or cell specimens that are interpreted by physicians. Clinical chemistry
testing is characterized by blood or urine specimens that are interpreted
through highly automated processes. Net revenues by test type of test for fiscal
year 1998, 1997 and 1996 are presented below:
Year Ended December 31
----------------------------------------
1998 1997 1996
----------------------------------------
Anatomic pathology testing $48,151,160 $43,923,487 $36,971,234
Clinical chemistry testing 14,030,343 16,963,706 $19,027,761
----------------------------------------
Consolidated net revenues $62,181,503 $60,887,193 $55,998,995
========================================
The Company's operations are conducted entirely in the United States since
the discontinuation of its international operations, the liquidation of which
was completed in 1998. No customer accounted for more than 10% of the Company's
revenues; however, in 1998, 1997 and 1996, respectively, approximately 33%, 37%
and 40% of the Company's net revenues were derived from testing performed for
beneficiaries under the Medicare and Medicaid programs (primarily Medicare).
(2) ACQUISITIONS
Effective February 1, 1998, the Company acquired certain assets of a
pathology laboratory in Tampa, Florida ("Pathologists Reference Laboratory" or
"PRL"). The acquisition price was approximately $558,000 (including acquisition
costs), of which $359,590 was paid through March 31, 1998 and the balance was
satisfied through the assumption of certain liabilities. The purchase price
consisted primarily of trade receivables for ($265,000) and customer lists for
($164,000), and the acquisition has been accounted for pursuant to the purchase
method of accounting. Pro forma consolidated net revenue for the year ended
December 31, 1998 adjusted as if the acquisition had occurred January 1, 1998
approximate $62.6 million. Pro forma consolidated net income and earnings per
share would not differ materially from the reported amounts.
(3) SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation -
The consolidated financial statements include the accounts of the Company
and all of its subsidiaries. All significant intercompany transactions have been
eliminated in consolidation.
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Use of Estimates -
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents -
The Company considers all highly liquid instruments purchased with an
original maturity of three months or less to be cash equivalents. At both
December 31, 1998 and 1997, the Company had approximately $13 million and $12
million, respectively, invested in short-term U.S. treasury funds with
maturities of less than three months. The carrying amount of the cash
equivalents approximates its fair value due to the relatively short period to
maturity of these instruments. Interest income per the consolidated statements
of operations is presented net of interest expense of $32,529, $26,869 and
$77,466 for 1998, 1997 and 1996, respectively.
Inventory -
Inventory consists primarily of bulk reagents, specimen collection kits
and devices. Inventories are stated at the lower of cost or market. Cost is
determined using the first-in, first-out method.
Property and Equipment -
Property and equipment are stated at cost. Major improvements which add to
productive capacity or extend the life of an asset are capitalized while repairs
and maintenance are charged to expense as incurred.
Effective January 1, 1998, the Company adopted Statement of Position
("SOP") 98-1 "Accounting for Costs of Computer Software Developed or Obtained
for Internal Use." In accordance with SOP 98-1, the Company has capitalized
approximately $443,000 in internally developed software costs in 1998. These
costs relate to the purchase of external materials and direct payroll costs
associated with software development. The Company is amortizing these costs on a
straight-line basis over five years.
Intangible Assets -
Intangible assets are amortized on a straight-line basis over the
respective economic life as follows:
Years
-----
Customer lists 7
Non-compete agreements 4-5
The Company periodically reviews the anticipated revenues related to
intangible assets to determine whether any adjustments to their carrying values
are necessary. During 1996, the Company recorded an accelerated amortization
charge of approximately $44,000, based on the Company's revised estimate of
future benefits from a customer list.
Revenue Recognition -
Revenues are recognized in the period in which services are provided.
Revenues subject to Medicare and Medicaid, direct physician and hospital billing
are based on fixed reimbursement fee schedules. All remaining revenues subject
to third-party reimbursement are recorded at estimated reimbursable amounts
based on Uniform Customary Charges. Such estimates are revised periodically
based upon the Company's actual reimbursement experience.
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Depreciation and Amortization -
Laboratory and office equipment is depreciated using the straight-line
method over a useful life of two to seven years. Leasehold improvements are
amortized over the shorter of their economic useful life or the remaining life
of the lease.
Research and Development -
Research and development costs are charged to expense as incurred.
Income Taxes -
The Company utilizes the liability method of accounting for income taxes
as set forth in Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes." Under this method, deferred income taxes are determined based
on the difference between the financial statement and tax bases of assets and
liabilities using presently enacted tax rates and regulations.
Earnings Per Share -
In 1997, the Company adopted Statement of Financial Accounting Standards
No. 128 "Earnings per share," effective December 15, 1997. Basic earnings per
share have been computed based on the weighted average number of common shares
outstanding during each year. Diluted earnings per share have been computed
based on the weighted average number of common shares and common equivalent
shares outstanding during each year. Common equivalent shares outstanding
include the common equivalent shares calculated for warrants and stock options
under the treasury stock method. Reported earnings per share for all prior
periods have been restated.
Below is a reconciliation of the numerators and denominators of the basic and
diluted EPS computations:
1998 1997 1996
---- ---- ----
BASIC EARNING PER SHARE:
Weighted-average number of common
shares outstanding 6,677,524 6,430,060 6,151,061
DILUTED EFFECT OF:
Stock options 224,556 378,190 136,098
---------- --------- ---------
DILUTED EARNINGS PER SHARE:
Weighted-average number of common
shares outstanding 6,902,080 6,808,250 6,287,159
========== ========== ==========
NET INCOME $2,954,330 $3,297,697 $2,170,116
========== ========== ==========
BASIC EARNINGS PER SHARE $0.44 $0.51 $0.35
========== ========== ==========
DILUTED EARNINGS PER SHARE $0.43 $0.48 $0.35
========== ========== ==========
Options to purchase 474,756 shares of common stock at prices ranging from
$7.625 and $12.25 per share were outstanding as of December 31, 1998 but were
not included in the computation of diluted earnings per share because the
options' exercise price was greater than the average market price of common
shares.
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Reclassifications -
Certain reclassifications have been made to prior year amounts to conform
to the classifications used in the current year presentation.
(4) INCOME TAXES
The income tax provisions for the years ended December 31, 1998, 1997 and
1996 consist of the following:
Year Ended December 31
----------------------------------------
1998 1997 1996
----------------------------------------
Current
Federal $2,080,854 $2,444,187 $1,387,967
State 540,088 721,544 446,091
----------------------------------------
Total Current 2,620,942 3,165,731 1,834,058
----------------------------------------
Deferred
Federal (280,806) (598,785) (152,112)
State (85,193) (154,412) (44,841)
----------------------------------------
Total Deferred (365,999) (753,197) (196,953)
----------------------------------------
Total provision for income taxes $2,245,943 $2,412,534 $1,637,105
========================================
The reasons for the differences between the statutory and effective rates are
as follows:
Year Ended December 31
----------------------------------------
1998 1997 1996
----------------------------------------
Statutory federal income tax rate 34.0% 34.0% 34.0%
State taxes, net of federal tax benefit 5.8 6.6 7.0
Non-deductible expenses 1.7 1.3 2.9
Non-deductible write-down of -- (.1) .7
investment in stock
Other 1.7 .4 (1.6)
========================================
43.2% 42.2% 43.0%
========================================
The net deferred tax asset is a result of the following temporary
differences:
Year Ended December 31
----------------------------------------
1998 1997 1996
----------------------------------------
Allowance for bad debts $ 407,533 $ 520,986 $428,761
Accrued expenses 639,585 417,457 (4,395)
Depreciation 823,822 416,824 95,067
Compensation not currently recognized 131,347 215,103 180,126
for tax reporting
International restructuring reserve -- 72,835 196,417
Amortization 42,441 43,783 37,264
Other 8,259 -- 550
========================================
$2,052,987 $1,686,988 $933,790
========================================
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) LEASE OBLIGATIONS
Included in property and equipment at December 31, 1998 and 1997 is
laboratory and office equipment held under capitalized leases as follows:
1998 1997
Property and equipment $303,325 $278,645
Less - accumulated depreciation (184,156) (135,181)
======================
$119,169 $143,464
======================
The future minimum lease payments under non-cancelable operating leases
and the present value of future minimum capital lease payments at December 31,
1998 are:
Capital Operating
Leases Leases
1999 $53,152 $1,119,321
2000 36,176 1,150,214
2001 34,440 1,083,784
2002 15,756 1,063,863
2003 -- 430,464
Thereafter -- 34,616
------------------------
Minimum lease payments 139,524 4,882,261
Less - amount representing interest 16,515 --
========================
Present value of total minimum lease payments $123,009 $4,882,261
========================
Total rental expense relating to operating leases for the years ended
December 31, 1998, 1997, and 1996 was $1,117,967, $997,869 and $1,041,127,
respectively.
The Company leases office and laboratory space at two facilities in
Stratford, Connecticut. The leases expire in May 2003 and contain options to
renew for up to three years. The annual rent on these leases will be increased
by a pro rata portion of the increase in real estate taxes and the increase in
common area maintenance. The Company also leases an office in Stamford,
Connecticut and a record storage facility in Stratford, Connecticut. The
Stamford lease expires in November 2000 with an option to renew for up to three
years. The record storage facility lease expires in May 2004.
The Company also leases four regional sales offices located in Florida,
North Carolina, Texas and Ohio. The terms of the leases range from one to three
years.
In March 1996, the Company executed a lease for a laboratory facility in
Wilmington, Ohio with a five-year term commencing April 1, 1996 and a renewal
option for five additional terms of three years each.
In connection with the acquisition of PRL (see Note 2), the Company
entered into a lease for an office and laboratory facility in Tampa, Florida for
a five-year term commencing January 31, 1998 with an option to renew for an
additional five-year period. In addition, the Company assumed leases for four
branch offices in Florida with remaining terms of up to two years.
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) STOCK-BASED COMPENSATION PLANS
In June 1991, the Company adopted the 1991 Stock Incentive Plan which
provides for up to 400,000 shares of the Company's Common Stock, par value $.01
per share ("Common Stock"), to be reserved for potential future issuance of
stock options or awards. This plan is the successor to the Company's previous
plan which expired. In June 1994, the Company offered certain officers and key
employees the opportunity to revise the terms of their original stock options
issued in 1991, 1992 and 1993; all such revisions are reflected in the
information presented below. As of December 31, 1998, 33,693 shares of Common
Stock are available under the 1991 Stock Incentive Plan for future issuance. The
majority of the options vest 40% in the second year after grant and 20% each
year thereafter and expire ten years from the original grant date.
In October 1996, the Company's shareholders approved the Company's
adoption of the 1996 Stock Incentive Plan, which provides for up to 700,000
shares of Common Stock to be reserved for potential future issuance of stock
options or awards. This plan is the successor to the 1991 Stock Incentive Plan
for which only a limited number of shares of Common Stock remain available for
grants. As of December 31, 1998, 10,629 shares of Common Stock are available
under the 1996 Stock Incentive Plan. The majority of options issued to officers
and key employees of the Company vest at a rate of 40% in the second year after
grant and 20% per year thereafter or 40% in the third year after grant and 20%
per year thereafter and expire ten years from the original date of grant. The
majority of options issued to directors vest at a rate of 10% per quarter and
expire ten years from the original date of grant.
The Company accounts for these plans under Accounting Principles Board
Opinion No. 25, under which no compensation cost has been recognized. Had
compensation cost for these plans been determined consistent with the Statement
of Financial Accounting Standards No. 123, the Company's net income and earnings
per share would have been reduced to the following pro forma amounts:
1998 1997 1996
---- ---- ----
Net Income: As Reported $2,954,000 $3,298,000 $2,170,000
Pro Forma $2,300,000 $2,704,000 $1,586,000
Basic earnings per
share: As Reported $.44 $.51 $.35
Pro Forma $.34 $.42 $.26
Diluted earnings As Reported $.43 $.48 $.35
per share: Pro Forma $.33 $.40 $.25
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For purposes of the pro forma information above, the fair value of each
option grant is estimated on the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions used for grants in
1998, 1997 and 1996,: risk-free interest rates of 5.38%, 6.52% and 6.67%,
respectively; expected volatility of 71%, 74% and 80%, respectively; and
expected lives of 8.6 years for 1998 and 1997 and 8.1 years for 1996. A summary
of the status of the Company's two fixed stock option plans as of December 31,
1998, 1997 and 1996, and changes during the years ending on those dates is
presented below:
-------------------------------------------------------
1998 1997 1996
-------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
FIXED OPTIONS SHARES PRICE SHARES PRICE SHARES PRICE
- ------------- ------ ----- ------ ----- ------ -----
Outstanding at
beginning of year 781,458 $7.24 597,676 $6.00 397,153 $5.42
Granted 265,060 7.13 338,351 8.61 296,550 6.43
Exercised (43,584) 4.99 (51,764) 4.81 (23,621) 4.56
Forfeited / canceled (118,480) 7.53 (102,805) 5.65 (72,406) 5.06
--------- --------- --------
Outstanding at end of
year 884,454 7.28 781,458 7.24 597,676 6.00
------- ---- ------- ---- ------- ----
Options exercisable at
year-end 203,993 6.67 152,218 6.24 120,512 6.35
Weighted-average fair
value of options
granted $5.43 $6.82 $5.19
-------------------------------------------------------
The table below contains information with respect to the 884,454 options
outstanding for the Company's 1991 and 1996 Stock Incentive Plan as of December
31, 1998:
EXERCISE PRICE EXERCISABLE OPTIONS
-------------------------- ------------------------
WEIGHTED
OPTIONS WEIGHTED REMAINING AVERAGE
OUTSTANDING RANGE AVERAGE CONTRACTUAL OPTIONS EXERCISE
----------- ----- ------- ----------- ------- --------
LIFE PRICE
129,774 $4.13 - $5.00 $4.96 5.7 90,409 $4.82
708,698 $6.01 - $9.00 $7.51 8.9 78,734 $7.05
45,982 $9.01 - $10.75 $10.40 3.5 34,850 $10.62
In addition to the disclosures above related to options granted under the
Company's 1991 Stock Incentive Plan and 1996 Stock Incentive Plan, the
disclosure that follows relates to options granted pursuant to employment
agreements or otherwise not under such plans.
In July 1995, the Company adopted the DIANON Systems, Inc. Employee Stock
Purchase Plan (the "ESPP" or "Plan") as described in Section 423 of the Internal
Revenue Code. The Plan provides for the sale of not more than 300,000 shares of
Common Stock, subject to adjustments in the event of stock splits and other
changes in capitalization. The Plan provides that all shares issued pursuant to
the Plan be treasury shares acquired by the Company in open market transactions
and that no shares issued will be authorized but unissued Common Stock.
Commencing on August 15, 1995, the Company offered the ESPP to eligible
employees as defined by the Plan at a purchase price equal to the lesser of 85%
of the market price at the date of grant or 85% of the market price at the date
of purchase or as otherwise defined in the grant offering.
In May 1996, the Company granted an officer options to purchase 200,000
shares of Common Stock at $5.69 per share pursuant to the terms of an employee
agreement. These options vested 40% in May 1998 and 20% over each year
thereafter.
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In October 1996, the Company granted options to purchase 10,000 shares of
Common Stock at $7.13 per share to an outside director of the Company, in
replacement of options issued in June 1993. These options vested immediately and
expire ten years from the date of grant.
(7) RELATED PARTIES
The Company pays a stockholder, who is also Chairman Emeritus, and who was
a director until January 1995, a royalty of 6% of revenue on sales of certain
technology covered by a license agreement. In addition, the Company provides
this stockholder with certain insurance benefits, the use of an automobile and
the reimbursement of expenses incident to his performance as a consultant to the
Company. The Company paid licensing and royalty fees to this stockholder of
approximately $27,000, $42,000 and $79,000 during the years ended December 31,
1998, 1997 and 1996, respectively.
In 1995, the Company entered into a three-year research and development
agreement with Brigham & Women's Hospital, Inc. The agreement required the
Company to make quarterly payments of $30,000 in exchange for an option to
obtain rights in certain existing inventions as well as inventions developed
during the course of the research in the areas of cancer detection and
diagnosis. The research was to be conducted by a director of the Company. The
Company paid $8,000, $60,000 and $120,000 under this agreement in 1998, 1997 and
1996, respectively. The Company terminated this agreement effective as of June
30, 1997 and has made all required payments. In addition, the Company made
payments to Brigham & Women's Hospital, Inc. of $30,000 in 1996 for consulting
services.
Pursuant to his employment agreement, the President of the Company
received a loan in 1996 totaling $150,000 which bears interest at 5.9%, payable
annually, and is repayable upon termination with the Company. In addition, the
loan principal will be forgiven at a rate of $2,500 per month over the period
January 1998 through December 2002 if the President continues to be employed by
the Company.
In the fourth quarter 1997, the Company entered into a one-year consulting
and proprietary information and inventions agreement with Jeffrey L. Sklar,
M.D., Ph.D., a director of the Company. The agreement requires the Company to
make quarterly payments at the beginning of each quarter for $5,000 in exchange
for delivery of services for molecular diagnosis. The Company paid $15,000 under
this agreement in 1998 and $5,000 in 1997.
(8) COMMITMENTS AND CONTINGENCIES
The Company is involved in certain legal matters which periodically arise
in the normal course of business. Management believes that the outcome of these
legal matters will not have a material adverse effect on the financial position
and results of operations of the Company.
The Company operates in the medical laboratory industry, which is subject
to numerous federal and state laws and regulations. In addition, a significant
portion of the Company's net revenue is from payments by the
government-sponsored Medicare and Medicaid programs. These programs have
extensive compliance requirements, and the payments made thereunder are subject
to audit and adjustment by applicable regulatory agencies. Failure to comply
with these laws and regulations, or the results of regulatory audits and payment
adjustments, could have a material adverse effect on the Company's financial
position and results of operations.
On November 19, 1997, a suit was filed against the Company in the United
States District Court, District of South Carolina (Frances P. Hadden v. DIANON
Systems, Inc.). The complaint alleged, among other things, medical malpractice
due to an incorrect diagnosis. The claim was settled in 1998 by the Company's
insurance carrier, with the cost to the Company limited to the policy
deductible.
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Prior to 1998, the Medical Director of the Connecticut Medicare carrier to
whom the Company submits its Medicare claims orally expressed the view that some
amount of money which the carrier has paid to the Company for certain pathology
services involving DNA measurements in prostate tumor cells (morphometric
analysis of tumor) potentially is recoverable by the carrier. (The company is
not presently submitting claims for this service.) The carrier Medical Director
has never reduced his view to writing or otherwise asserted a claim.
Accordingly, at this time, the Company cannot evaluate any such possible claim,
or the probability of assertion of any such claim.
During 1997, the Company was made aware that an agent based in the
Hartford Connecticut branch of the U.S. Department of Health and Human Services
Office of the Inspector General ("OIG") was investigating the Company's practice
of supplying pathology specimen collection devices without charge to physician
customers as well as unspecified billing issues that had been raised by the
local Medicare carrier. The company believes that its practices with respect to
specimen collection devices were proper, and a letter describing the Company's
actions and its views regarding applicable regulations was sent by the Company
to the OIG. That letter also requested information about any billing issues of
concern to the OIG so that the Company could address them. As of the date of
this report, the Company had not received a response from or otherwise been
contacted by the OIG regarding these matters, and has not received any formal
notification regarding the matter.
Although the Company seeks to structure its practices to comply with all
applicable laws, and management believes such practices are in compliance,
uncertainty nevertheless exists as to how these matters may develop, and the
Company currently is unable to predict their impact, if any, on the Company.
While management does not believe that this matter will have a material adverse
effect on the Company's financial condition, if the carrier and/or OIG agent
were to pursue and prevail on these matters, any significant recoupment of funds
or civil or criminal penalty potentially resulting from such proceedings could
have a material adverse effect on the Company's business and its results of
operations.
(9) EMPLOYEE BENEFIT PLAN
The Company has established a 401(k) employee benefit plan pursuant to
which participants receive certain benefits upon retirement, death or
termination of employment. The Company is required to contribute amounts equal
to 20% of the contributions made by employees up to 1% of their total annual
salary (subject to tax code limits). The Company contributed approximately
$132,000, $105,000 and $88,000 to the plan during 1998, 1997 and 1996,
respectively. The Company offers no other post-retirement benefits or
post-employment benefits to its employees.
(10) RIGHTS AGREEMENT
On April 29, 1994, the Board of Directors of DIANON Systems, Inc. declared
a dividend distribution of one Right for each outstanding share of Common Stock,
par value $.01 per share, of the Company to stockholders of record on May 10,
1994. Each Right entitles the registered holder to purchase from the Company a
unit ("Unit") consisting of one one-hundredth of a share of Series A Junior
Participating Preferred Stock, par value $.01 per share, of the Company, at a
price of $20 per Unit, subject to adjustment, upon change of control in the
Company, as defined in the rights agreement.
(11) SEVERANCE COSTS
The Company recorded charges of approximately $212,000, $324,000 and
$148,000 during 1998, 1997 and 1996, respectively, for severance costs as a
result of streamlining its operations and of the resignation of certain officers
of the Company.
DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(12) PRIVATE PLACEMENT
On October 5, 1995, the Company completed a $5,612,000 private placement
with an investor for one million shares of Common Stock and a two-year warrant
for 800,000 shares exercisable at $6.00 per share of Common Stock (except as
otherwise described below). The Company received cash of $5,316,000 and a
two-year promissory note for $296,000 bearing 7% interest, which note was
classified as a reduction to additional paid-in capital. Some or all of the
warrants could be exercised at a price of $5.00 at any time on or before October
31, 1996. Upon such election the Company would be required to extinguish as an
adjustment to the purchase price paid for such warrants, for each such warrant
for which such election has been made, $0.37 of the principal amount of the note
upon payment of the interest due on such extinguished amount for the outstanding
period. If the warrants for 800,000 shares were all exercised on or before
October 31, 1996, the two year promissory note for $296,000 would be fully
extinguished. On August 20, 1996, the Company's Board of Directors approved an
amendment to the terms of the warrants to extend from October 4, 1996 to October
31, 1996, the date through which the warrants could be exercised at $5.00 per
share. The amendment was approved in connection with the scheduling of the
Company's Annual Meeting for October 24, 1996 to enable voting at such meeting
on the Company's agreement to enable the investor to vote shares of the
Company's common stock owned by such investor and certain affiliates
representing up to 20% of the total voting power of the Company's voting
securities outstanding from time to time to be completed prior to the expiration
of the $5.00 per share exercise price. The Company's agreement was approved at
the Company's Annual Meeting on October 24, 1996. On October 29, 1996, the
investor exercised warrants for all 800,000 shares and in exchange for the
payment of approximately $4.0 million in cash representing the aggregate
exercise price of such warrants and interest on the principal amount of the
two-year promissory note for the outstanding period, the Company issued to the
investor 800,000 shares of its Common Stock and fully extinguished and cancelled
the promissory note.
(13) SUBSEQUENT EVENT
On January 6, 1999, the Company signed a letter of intent to acquire
substantially all the assets of Kyto-Meridien Diagnostics, LLC, an outpatient
OB/Gyn laboratory with locations in Woodbury and New City, New York. The Company
is in the process of conducting due diligence and, subject to the result of this
process, expects to close the acquisition in the second quarter of 1999.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To DIANON Systems, Inc.:
We have audited in accordance with generally accepted auditing standards,
the consolidated financial statements of DIANON Systems, Inc. and subsidiary
companies included in this Form 10-K and have issued our report thereon dated
February 23, 1999. Our audits were made for the purpose of forming an opinion on
the basic consolidated financial statements taken as a whole. The schedule
listed in the index to consolidated financial statements is the responsibility
of the Company's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in the audits of the basic consolidated financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Stamford, Connecticut
February 23, 1999
DIANON SYSTEMS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
Balance at
Beginning Provision Charges to Balance at
of Year for Allowance End of Year
Allowance
------------------------------------------------
For the year ended December 31, 1996:
Allowance for bad debts $786,920 $270,000 $ -- $1,056,920
Domestic restructuring reserve 4,557 -- 4,557 --
International restructuring reserve 162,041 -- 6,566 155,475
Non-deductible write-down of
investment in stock 529,625 -- 529,625 --
For the year ended December 31, 1997:
Allowance for bad debts 1,056,920 300,294 65,119 1,292,095
International restructuring reserve 155,475 -- 135,404 20,071
For the year ended December 31, 1998:
Allowance for bad debts (a) 1,292,095 75,000 334,036 1,033,059
International restructuring reserve 20,071 -- 20,071 --
(a)The bad debt provision of $75,000 for the year ended December 31, 1998
represents a purchase accounting adjustment related to the acquisition of
PRL, rather than a charge to expense.
EXHIBIT INDEX
Exhibit
Document Page
No. Reference Reference
--- --------- ---------
3.1 Restated Certificate of Incorporation of the Company,
as amended through June 12, 1991 (incorporated by
reference to Exhibit 3.1 of the Registrant's
Registration Statement No. 33-41226).
3.2 Restated By-Laws of the Company, as amended through
October 24, 1996 (incorporated by reference to Exhibit
4.2 of the Registrant's Registration Statement No.
333-18817).
3.3 Restated By-Laws of the Company, as amended through
February 2, 1997 (incorporated by reference to Exhibit
4.2 of the Registrant's Registration Statement No.
333-18817).
10.1 Consulting Agreement, dated August 4, 1989, between
DIANON Systems, Inc. and Nonda Katopodis, Ph.D.
(incorporated by reference to Exhibit 10.7 of the
Registrant's Registration Statement No. 33-41226).**
10.2 Executive Vesting Agreement, dated as of June 11,
1991, between DIANON Systems, Inc. and James B.
Amberson, M.D. (incorporated by reference to Exhibit
10.13 of the Registrant's Registration Statement No.
33-41226).**
10.3 1991 Stock Incentive Plan (incorporated by reference
to Exhibit 10.17 of the Registrant's Registration
Statement No. 33-41226).**
10.4 Management Incentive Plan (incorporated by reference
to Exhibit 10.18 of the Registrant's Registration
Statement No. 33-41226).**
10.5 Stock Option Grant to Walter O. Fredericks, dated
April 27, 1990 (incorporated by reference to Exhibit
10.23 of the Registrant's Registration Statement No.
33-41226).**
10.6 Stock Option Grant to Richard A. Sandberg, dated June
12, 1991 (incorporated by reference to Exhibit 10.24
of the Registrant's Registration Statement No.
33-41226).**
10.7 Stock Option Grant to Richard A. Sandberg, dated June
12, 1991 (incorporated by reference to Exhibit 10.25
of the Registrant's Registration Statement No.
33-41226).**
10.8 Lease Agreement, made as of February 14, 1989, between
Watson Boulevard Development Limited Partnership, as
lessor, and DIANON Systems, Inc., as lessee, for
premises located at 200 Watson Boulevard (incorporated
by reference to Exhibit 10.29 of the Registrant's
Registration Statement No. 33-41226).
10.9 License Agreement, dated June 9, 1983, between
Sloan-Kettering Institute for Cancer Research and N-K
Laboratories Limited Partnership (incorporated by
reference to Exhibit 10.30 of the Registrant's
Registration Statement No. 33-41226).
10.10 License Agreement, dated July 29, 1987, between
University of Rochester and DIANON Systems, Inc.
(incorporated by reference to Exhibit 10.32 of the
Registrant's Registration Statement No. 33-41226).
10.11 Development Agreement, effective September 25, 1987,
between Connecticut Product Development Corporation
and DIANON Systems, Inc. (incorporated by reference to
Exhibit 10.33 of the Registrant's Registration
Statement No. 33-41226).
10.12 Stock Option Grant to James B. Amberson, M.D., dated
April 23, 1991 (incorporated by reference to Exhibit
28.1 to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1991).**
10.13 Stock Option Grant to Richard A. Sandberg, dated June
12, 1991, as amended (incorporated by reference to
Exhibit 10.37 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1991).**
10.14 Asset Purchase Agreement, dated April 30, 1993, by and
among the Registrant and Molecular Oncology, Inc., and
Oncologix, Inc. (incorporated by reference to Exhibit
1.1 to the Registrant's Form 8-K dated April 30, 1993,
filed with the Securities and Exchange Commission on
May 14, 1993).
10.15 Asset Purchase Agreement, dated June 29, 1993, by and
among the Registrant and Collaborative Research, Inc.
(incorporated by reference to Exhibit 1.2 to the
Registrant's Form 8-K dated June 29, 1993, filed with
the Securities and Exchange Commission on July 13,
1993).
10.16 Term Loan Agreement, dated July 14, 1993, by and among
the Registrant and the Union Trust Company
(incorporated by reference to Exhibit 10.34 to the
Registrant's Annual Report on Form 10-K/A Amendment 1
for the year ended December 31, 1993, filed with the
Securities and Exchange Commission on April 28, 1994).
10.17 Rights Agreement, dated April 29, 1994, by and among
the Registrant and American Stock and Trust Company,
as Rights Agent (incorporated by reference to Exhibit
1 to the Registrant's Form 8-K dated April 29, 1994,
filed with the Securities and Exchange Commission on
May 9, 1994).
10.18 Severance Agreement, dated January 20, 1995, by and
among the Registrant and John P. Davis (incorporated
by reference to Exhibit 10.36 to the Registrant's
Annual Report on Form 10-K for the year ended December
31, 1995, filed with the Securities and Exchange
Commission on March 29, 1996).**
10.19 Employment Agreement, dated May 3, 1996, by the
Registrant and Kevin C. Johnson (incorporated by
reference to Exhibit 10.37 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended
June 30, 1996).**
10.20 Executive Employment Agreement, dated September 1,
1996, by the Registrant and Richard A. Sandberg
(incorporated by reference to Exhibit 10.38 to the
Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996).**
10.21 Employment Agreement, dated September 1, 1996, by the
Registrant and James B. Amberson, M.D. (incorporated
by reference to Exhibit 10.39 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996).**
10.22 Executive Employment Agreement, dated September 1,
1996, by the Registrant and James B. Amberson, M.D.
(incorporated by reference to Exhibit 10.40 to the
Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996).**
10.23 Severance Agreement, dated September 27, 1996, by the
Registrant and Carl R. Iberger (incorporated by
reference to Exhibit 10.41 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996).**
10.24 Employment Agreement, dated September 30,1996, by the
Registrant and David R. Schreiber (incorporated by
reference to Exhibit 10.42 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996).**
10.25 Employment Agreement, dated November 18, 1996, by the
registrant and Steven T. Clayton.**
10.26 Severance Agreement dated November 18, 1996, by the
registrant and Daniel J. Cronin, III.**
10.27 Amendment dated as of October 4, 1995 to Rights
Agreement dated as of April 29, 1994 between the
Registrant and American Stock Transfer and Trust
Company, as Rights Agent (incorporated by reference to
Exhibit No. 1 to the Registrant's Form 8-K dated
October 30, 1996 filed with the Securities and
Exchange Commission on November 8, 1995).
10.28 1996 Stock Incentive Plan (incorporated by reference
to Appendix A to the Registrant's Statement on
Schedule 14A filed with the Securities and Exchange
Commission on September 23, 1996).**
10.29 Stock and Warrant Purchase Agreement, dated as of
October 4, 1995, among the Gilbert Family Trust, the
G. S. Beckwith Gilbert I.R.A. Contributory Account, G.
S. Beckwith Gilbert and the Registrant.
10.30 Registration Rights Agreement, dated as of October 4,
1995, among the Gilbert Family Trust, the G. S.
Beckwith Gilbert I.R.A. Contributory Account, G. S.
Beckwith Gilbert and the Registrant.
10.31 Warrant No. 1, dated as of October 4, 1995, by the
Registrant in favor of G. S. Beckwith.
10.32 Promissory Note, dated October 4, 1995, by G. S.
Beckwith Gilbert in favor of the Registrant.
10.33 Stock Option Grant dated October 24, 1996 by the
Registrant to Andre de Bruin.**
10.34 Stock Option Grant dated November 4, 1996 by the
Registrant to Jeffrey M. Sklar, M.D., Ph.D.**
10.35 Loan Agreement dated December 3, 1996 by the
Registrant to Kevin C. Johnson).**
10.36 Form of standard Stock Option Grant for outside
directors.**
10.37 Amendment to Warrant Certificate No. W-1 dated as of
October 2, 1996 between the Registrant and G. S.
Beckwith Gilbert.
10.38 Severance Agreement dated February 27, 1997 by the
Registrant and Richard A. Sandberg.**
10.39 Amendment dated April 30, 1997 by the Registrant and
Richard A. Sandberg.**
10.40 Security Agreement dated April 30, 1997 by the
Registrant and Richard A. Sandberg.**
10.41 Secured Promissory Note dated April 30, 1997 by the
Registrant and Richard A. Sandberg.**
10.42 Non-Compete Agreement dated September 3, 1997 by the
Registrant and Vernon L. Wells.**
10.43 Severance Agreement dated September 15, 1997 by the
Registrant and Robert C. Verfurth.**
10.44 Consulting and Proprietary Information and Inventions
Agreement dated October 1, 1997 by the Registrant and
Jeffrey L. Sklar, M.D., Ph.D.
10.45 Severance Agreement dated January 27, 1998 by the
Registrant and Vernon L. Wells (filed herewith).**
11.1 Statement re: computation of per share earnings. *
22.1 List of Subsidiaries of the Company (incorporated by
reference to Exhibit 22.1 of the Registrant's
Registration Statement No. 33-41226).
23.1 Consent of Arthur Andersen LLP (filed herewith). 57
27.1 Financial Data Schedule. 58
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* Not applicable or contained elsewhere herein.
** A management contract or compensatory plan or arrangement required
to be filed as an exhibit to this form pursuant to Item 14(c) of
this report.